Reproduced with permission of 1 European Journal of Commercial Contract Law (1/2009) 19-28
Fundamental Breach in Documentary Sales Contracts
The Doctrine of Strict Compliance with the Underlying Sales Contract
Maartje Bijl [*]
- Conclusion
1. INTRODUCTION
International commercial contracts, such as international sales of goods, often involve large sums of money and large shipments of goods. Ever present and inherent to any commercial contract, but especially international transactions, is the threat of non-payment by the buyer or non-performance by the seller. Parties may not know much about each other, in particular about the financial stability and trustworthiness of their trading partner. The problem is compounded by uncertainty surrounding the applicable national law, where parties have not made an explicit choice of law in their contract. And even if a national law is chosen by the parties, at least one of the contracting parties will have to deal with a legal system that is not his own. The potential costs, inconvenience and delay involved in pursuing a recovery case against a buyer for non-payment or against a seller for non-delivery may well prove to outweigh what is to be gained from the contract in the first place.
Where parties have established a business relationship, the seller may extend credit to the buyer. In an international sale, however, this scenario is highly unlikely, as the risks inherent to such a transaction would be too great. In such situations, when suppliers or vendors are selling and purchasing goods to and from overseas customers with whom they have not established a business relationship, parties tend to search for additional means of securing performance and payment beyond the mere agreement in the contract. Such security may be achieved by means of, for instance, a letter of credit. The involvement of banks in international sales increases the costs of the transactions, but minimises the element of risk.
When contracting parties have agreed to effectuate payment by means of a letter of credit, the buyer's bank takes upon itself the obligation to pay the purchase price when the seller tenders the documents that are stipulated in the letter of credit. The bank has no knowledge of the underlying contract or of the actual goods that are traded. The documents must therefore comply strictly with the terms of the credit. In most national legal systems there is no such thing as a letter of credit law.[1] As such, the principle of strict compliance has evolved from international banking practice.[2] Article 14 of the Uniform Customs and Practice for Documentary Credits (UCP 600)[3] holds important provisions concerning the application of the principle of strict compliance to the tender of the documents by the seller. Although the UCP do not apply unless they are incorporated into the text of the letter of credit (Article 1 UCP 600), in international trade almost all documentary credits are expressed to be subject to the UCP.[4]
This article examines whether a failure to deliver documents conforming to the terms of the letter of credit can constitute a fundamental breach of the underlying sales contract as defined by Article 25 of the Vienna Sales Convention (CISG) by the seller, and thereby enable the buyer to avoid the contract entirely (Article 49 CISG). In order for a buyer or a seller to avoid a contract under the CISG, the buyer or seller must prove that the breach is fundamental. Obviously, this will depend on the seriousness of the breach in question. And this, in turn, depends on the type of contract. It is perhaps in relation to the delivery of documents that the concept of fundamental breach is likely to cause most problems.[5] In a letter of credit transaction, payment is effected by the tender of conforming documents by the seller to a bank. Moreover, the documents represent the goods that are shipped to the buyer. The delivery of non-conforming documents might mean the delivery of non-conforming goods. As such, the documents play a crucial role in letter of credit transactions.
We will take a closer look at documentary sales contracts, more specifically those in which payment is effected through a letter of credit. However, before the main question in this article -- whether the failure to deliver conforming documents can constitute a fundamental breach -- can be considered, the exceptional character of letter of credit transactions must [page 19] be understood. This will be discussed in the following section. In section 3 the two fundamental principles governing the letter of credit transaction -- the principle of independence and the principle of strict compliance -- are considered. The concept of fundamental breach as set forth in Article 25 CISG will be discussed in section 4. Finally, in section 5, it is submitted that the underlying sales contract can indeed be affected by the fact that parties have agreed to the payment of the purchase price through a letter of credit. An essential part of a letter of credit transaction is the delivery of the documents, as this directly effects the payment of the purchase price. A failure to deliver documents that strictly comply with the terms of the credit by the seller, thereby hindering the buyer to performing his contractual obligations (i.e. payment of the purchase price by means of a letter of credit), may constitute a fundamental breach of contract by the seller, giving the buyer the right to avoid the sales contract.
2. LETTERS OF CREDIT
Under Article 2 UCP 600, a letter of credit is any arrangement, however named or described, whereby a bank (the issuing bank) acts at the request and on the instructions of a customer (the buyer/applicant) to make a payment to a third party (the seller/beneficiary) against stipulated document(s), provided that the terms and conditions of the credit are complied with. Once the buyer has concluded the contract with the seller in which a documentary credit clause has been incorporated, the buyer will request its bank (the issuing bank) to open a letter of credit in favour of the seller (the beneficiary). The buyer, as the applicant, will inform the issuing bank of the documentary requirements that it wishes to have inserted into the letter of credit. The issuing bank usually has its place of business in the buyer's country, whereas the seller operates from another country. Therefore the issuing bank may request a bank in the seller's country (which can be a branch office of the issuing bank) to take up the documents and make payment in its name (the advising or nominated bank -- Article 6a UCP 600).[6] The nominated bank then forwards the documents to the issuing bank against reimbursement.
All conditions stipulated in the letter of credit have to be documentary conditions. If a letter of credit contains conditions without stating the document(s) to be presented in compliance therewith, banks will deem such conditions as not stated and will disregard them (see Article 14h UCP 600). In other words, the buyer cannot require that the seller prove a fact that is not capable of being recorded in a document. All that he can require the seller to do is to submit documentation that records certain facts or conditions.
The bank's promise to pay is conditional upon the seller presenting evidence that the goods have been shipped to the port of destination, along with the other documents required by the sales contract and thus stipulated in the letter of credit. With regard to the payment mechanism, the whole transaction is based purely on documentation that the bank checks for compliance against the letter of credit; the documents are deemed to represent the goods. The result is that neither party to the transaction controls both the goods and the money at the same time. These requirements are essentially designed to ensure that the seller submits documentation that records its compliance with its obligations under the underlying sales agreement,[7] as well as to restrict the bank's involvement to the examination of the documents. The bank deals with documents, not with goods (see Article 5 UCP 600).
3. DOCTRINE GOVERNING THE LETTER OF CREDIT TRANSACTION
As was discussed in section 1, letter of credit law has developed largely through custom and international banking practice. The principles that are deemed to be the most important in letter of credit law are the principle of independence and the principle of strict compliance. Their development and significance are discussed in this section.
3.1. The Principle of Independence
In transactions involving a letter of credit, the bank is not party to the underlying contract. As such, letters of credit have an abstract character. This implies that the bank is not concerned with the specifics and the actual performance of the underlying contract. The conditions of the bank's duty to pay are to be found exclusively in the terms of the letter of credit and do not in any way depend on the performance of the seller's obligations under the contract of sale.[8] Article 4(a) UCP 600 stipulates that:
'[a] credit by its nature is a separate transaction from the sale or other contract on which it may be based. Banks are in no way concerned with or bound by such a contract, even if any reference whatsoever to it is included in the credit. ...'
Accordingly, when deciding whether to make payment under the credit in favour of a beneficiary, the bank may only look at the terms of the credit itself. The bank may not raise any defences that are available to the applicant in respect of the underlying agreement of sale.[9] The seller will thus always receive payment from the bank if he submits documents that comply with the credit, regardless of any developments in the underlying sales agreement. The bank should not be forced into the position in which it has to resolve disputes between the seller and buyer, because this would lead to extensive delays in payment and would make the [page 20] letter of credit unattractive as a commercial service.[10] If the doctrine of independence is not scrupulously observed, the continuance of the letter of credit system as the primary means of payment in international trade would be in danger.[11]
The only exception to the principle of independence is fraud committed by the beneficiary when tendering the documents. As De Rooy [12] has stated: 'No system can be effective if it is blind to something which is manifestly unreasonable.' If the bank discovers fraud in the documents that were tendered by the beneficiary, it is entitled to refuse payment even though the documents appear to be in conformity with the terms of the letter of credit. This entails that the beneficiary, if he had been truthful in his representations, would have tendered documents that did not strictly comply with the terms of the letter of credit. The fraud, however, must be clear and evident to the bank, without the need for additional proof or having to investigate the actual circumstances surrounding the underlying contract.[13] A mere suspicion of fraud is not sufficient to set aside the independence principle.[14] Thus, even if a bank suspects fraud, it is obliged to pay under the letter of credit if the beneficiary has tendered documents that are in conformity with the letter of credit.
3.2. The Principle of Strict Compliance
The second principle governing letter of credit transactions is closely linked to the principle of independence. If the seller wishes to be paid under the letter of credit transaction, documents which strictly comply with the terms of the letter of credit must be tendered. The doctrine of strict compliance demands that the bank's verification of the documents upon presentation is both literal and exact. When applying the principle of strict compliance in its strictest sense, even the most trivial discrepancy allows a bank to reject the documents for non-conformity with the letter of credit.[15] This was first formulated in a 1927 decision handed down by an English court, in which Lord Sumner stated that:
'[T]here is no room for documents which are almost the same, or which will do just as well ... the bank which knows nothing officially of the details of the transactions financed cannot take upon itself to decide what will do well enough, and what will not. If it does as it is told it is safe; if it declines to do anything else, it is safe; if it departs from the conditions laid down, it acts at its own risk.'[16]
This decision has laid the groundwork for a long line of court rulings all over the world -- especially in the United Kingdom and the United States -- defining, refining and redefining the principle of strict compliance.
The UCP are fairly general in providing for a standard of documentary compliance and make no mention of the principle of strict compliance as such. However, Article 14(a) UCP 600 requires documents to 'appear on their face to be in accordance with the terms and conditions of the credit'. In tune with the doctrine of independence, Article 14(a) of the UCP 600 further provides that banks must make their checks 'on the basis of the documents alone'.[17] In this respect, the principle of strict compliance is linked to the independence principle. Banks act on behalf of the buyer within the limits delineated in the letter of credit alone. Whenever they go beyond these limits, the buyer can reject the bank's actions. The safest course for banks, and thus for the party tendering the documents (the seller), is obviously to follow the wording of the credit precisely.[18] However, Article 14(d) UCP 600 has added to the requirement of strict compliance that the documents do not need to be identical, but must not be in conflict with each other:
'Data in a document, when read in context with the credit, the document itself and international standard banking practice, need not be identical to, but must not be in conflict with data in that document, any other stipulated document or the credit.'[19]
Thus, subject to the UCP, banks cannot reject every document containing a misspelling or typographical error. In fact, banks are obliged to examine whether the documents that are tendered in a letter of credit transaction are in conformity with the credit not by determining merely whether they comply exactly to the terms of the credit, but whether they are consistent with each other, and a simple misspelling usually will not affect such consistency. Article 18(c) UCP 600 specifically stipulates that only the commercial invoice must contain a description of the goods that strictly conforms to the description in the letter of credit, whereas the other documents may contain a more general description, as long as this description is not inconsistent with the credit and the other documents (see Article 14(e) UCP 600).
Of course, it is of great importance that the description of the goods is clearly identifiable as the description in [page 21] the credit and that it is kept simple.[20] This remains the best method to avoid complications in the examination of the documents and to achieve the main goal of the letter of credit transaction and its strict compliance principle: to provide a secure payment mechanism.
4. FUNDAMENTAL BREACH IN TERMS OF THE VIENNA CONVENTION FOR THE INTERNATIONAL SALE OF GOODS
This article seeks to answer the question of whether non-compliance by one of the contracting parties with the terms of the letter of credit can constitute a fundamental breach of contract within the meaning of Article 25 CISG. For a proper discussion of the subject in this section, after a brief introduction to the CISG itself, the scope and meaning of the term 'fundamental breach' will be examined.
4.1. The CISG as the Relevant Law Governing the Sales Contract
The Vienna Convention on the International Sale of Goods 1980 (CISG), after ten years of preparatory work by UNCITRAL, was adopted in April 1980 at the United Nations Diplomatic Conference attended by sixty-two States. It later entered into force in January 1988, and today seventy-three countries are party to the Convention.[21] The CISG provides uniform rules for contracts for the international sale of goods. It governs both the formation of international sales contracts and provides the substantive law governing international sales in one concise document. In response to the problems resulting in the need for international unification, the CISG not only avoids the potential difficulties as to the choice of applicable law, but also offers parties a framework in which they can shape their rights and obligations with acceptable results.[22]
The CISG can be seen as an attempt to reconcile different legal traditions regarding the international sale of goods.[23] It was designed specifically to promote the progressive harmonisation and unification of international trade law [24] and to create a uniform international sales law [25] It thus reflects many general principals of contract law, even though the CISG is not necessarily the common denominator of an exercise in comparative law, but the result of a political negotiation process that was aimed at establishing a workable and suitable instrument for international sales.[26]
Uniformity in and unification of international commercial law are desirable and have been partly achieved, with the CISG being an important step in this process. However, these objectives presuppose that these provisions for international sales contracts will be given a uniform, neutral and internationally focused interpretation. Accordingly, Article 7(1) requires that the CISG be interpreted uniformly. The first guideline is its international character. In the first place, therefore, the CISG has to be interpreted autonomously. This means that the terms of the CISG should not simply be regarded as having the same meaning as identical terms that may exist in a domestic legal system. Recourse to domestic principles is not allowed.
The second guideline is the need to promote uniformity in the application of the CISG. A new autonomous method of interpretation is developed with the aid of case law and practice. The courts should try to take into account foreign case law (and academic writing) as persuasive authority when interpreting the CISG.[27] In fact, the relevant material is made available by several. databases and publications which are easily accessible, so that there is at least a reasonable basis for complying with the uniformity guideline. Article 7 CISG also points to the application of good faith in international trade. Good faith as a principle is not only applied to the interpretation of the CISG as a whole, but it also regulates the behaviour of the parties.
Where appropriate, use is made of the UNIDROIT Principles for Commercial Contracts (UNIDROIT Principles) [28] and the Principles of European Contract Law (PECL) [29] to interpret the relevant provisions of the CISG. It is still a somewhat controversial issue as to whether such principles may be used for 'gap-filling' under Article 7(2) CISG, although there are many legal authors who promote this idea.[30] The UNIDROIT Principles themselves explicitly offer that possibility in their preamble, which states that these principles may [page 22] be used, inter alia, to supplement international uniform law instruments. However, Article 7(2) CISG makes it clear that gaps in the CISG have to be filled by using first and foremost the general principles which are to be found within the CISG. This does not mean, however, that the UNIDROIT Principles cannot play any role in the gap-filling process: they can be used to corroborate a principle that has already been deduced from the CISG itself.[31]
4.2. Principal Obligations of the Buyer and the Seller under the CISG
Under the CISG, it is the principal responsibility of the buyer to pay the purchase price for the goods as set out in Articles 53 and 54 CISG. The general obligations of the buyer are summed up in Article 53, which restates in very broad language that the buyer must pay the price for the goods and take delivery thereof as required under the contract and the CISG. This duty to pay the price is further specified in Article 54 CISG, which provides that:
'[t]he buyer's obligation to pay the price includes taking such steps and complying with such formalities as may be required under the contract or any laws and regulations to enable payment to be made.'
These steps can include, as mentioned in the UNCITRAL Digest [32] and in a number of scholarly opinions,[33] the opening of a letter of credit, the establishment of security or obtaining a bank guarantee, or the acceptance of a bill of exchange.
Thus, as the letter of credit transaction commences when a buyer and a seller agree in their contract of sale that payment shall be effected by the furnishing of a letter of credit, it puts the buyer under an obligation to have such a letter of credit opened by a bank in favour of the seller. This is a condition precedent to the performance of all the seller's duties and clearly falls within the buyer's control. Failure to comply would be the buyer's sole responsibility and constitutes a breach of contract, which may be considered fundamental (see section 4.3).[34]
On the other hand, in a documentary sales transaction it is the responsibility of the seller to hand over any documents relating to the goods as set out in Articles 30 and 34 CISG.[35] Article 34 of the CISG provides (in part) that:
if the seller is bound to hand over documents relating to the goods, he must hand them over at the time and place and in the form required by the contract.'
As is the case with the delivery of non-conforming or defective goods in a contract for the sale of goods (Article 35 CISG), a failure to deliver conforming documents in a documentary sales contract amounts to a breach of contract. The delivery of clean documents is of the essence of the contract, which implies the buyer's right to reject a defective delivery.[36] Applied to a letter of credit transaction, this may also imply that the tender of non-conforming documents to the bank by the seller under the letter of credit constitutes a breach of contract. It must be noted, however, that both the CISG -- and the UCP provide for the possibility to re-tender the documents that were previously considered 'unclean'. Article 34 CISG grants this possibility without any further requirements other than that the seller needs to cure the defects within the time allowed by the sales contract, i.e. within the time allowed by the letter of credit. Thus, it is not the tender of non-conforming documents itself that constitutes the breach of contract, but the failure to deliver conforming documents within the time specified in the letter of credit.
Minor defects can be cured by the seller or excused by the buyer under Article 16(c) UCP 600, which stipulates that the bank will notify the seller of any discrepancies in the documents within five banking days. If the letter of credit has not yet expired the seller may re-tend the documents. If there is a serious offer to cure the defects in the documents -- within a reasonable time -- a fundamental breach does not occur and the buyer does not have the right to terminate the contract.[37] If the discrepancies in the documents do not affect the representation of the goods, the bank may also contact the buyer in order to obtain a waiver for [page 23] these minor discrepancies (Article 16(b) UCP 600), The buyer is under no obligation to grant a waiver, However, it is suggested here that under the CISG, parties ought to cooperate, Thus, even though under the UCP, a duty to waive irrelevant discrepancies does not exist, this may be different under the CISG despite the fact that the letter of credit is strictly separate from the underlying agreement (see section 3.1). The principle of independence is intended to prevent banks from having to investigate the facts of the underlying contract. Such protection is not appropriate where the parties to the underlying sales contract are concerned. The buyer and seller are fully aware of what was agreed upon in the contract, or at least are deemed to be. If a buyer knows that certain discrepancies will not have any effect on the delivery of the goods, it is submitted that he has an obligation under the CISG, based on the principle of good faith, to waive those discrepancies, The UNIDROIT Principles expressly state that contractual obligations may be implied under the maxim of good faith in Article 5.2. Moreover, Article 5.1.3 UNIDROIT Principles states that 'each party shall cooperate with the other party when such co-operation may reasonably be expected for the performance of that party's obligations.' The CISG does not contain a comparable rule. Nevertheless, it is widely accepted that under the CISG, additional obligations can be implied as well, in particular, a general duty to cooperate.[38]
Even after the time stipulated in the sales contract, the seller will, under Article 48(1) CISG have an additional opportunity to cure the defective goods and/or documents, This is, however, only possible if the seller can do so without unreasonable delay or inconvenience to the buyer.[39] It is submitted that in a letter of credit transaction such an opportunity is generally not available to the seller. Once the letter of credit has expired, the seller cannot re-tender the documents to cure any previous defects to effect payment under the credit. Clean documents may still be of value to the buyer in that they represent the goods, but payment can no longer be effected through the agreed letter of credit, as was agreed upon in the sales contract.
4.3. The Definition of Fundamental Breach
Under the CISG, the right to avoid the contract is conditional upon the buyer establishing that the breach was fundamental.[40]
The tender of strictly complying documents in order to effect payment under the letter of credit is a significant part of the sales contract. The bank is obliged to refuse to pay the price when the documents do not comply with the terms stipulated in the letter of credit. This implies that the tender of conforming documents is also an important part of the seller's obligations under the underlying contract. To establish whether the failure to comply with such an (implied) obligation under the sales contract constitutes a fundamental breach, consideration will here be given to the definition of a fundamental breach under the CISG. The Convention defines a fundamental breach in Article 25 CISG as follows:
'[a] breach of contract committed by one of the parties is fundamental if it results in such detriment to the other party as substantially to deprive him of what he is entitled to expect under the contract, unless the party in breach did not foresee and a reasonable person of the same kind in the circumstances would not have foreseen such a result.'
The definition of the concept of fundamental breach must be clear, especially when one considers the implications of a non-performance being defined as a fundamental breach: the buyer or seller will then be able to avoid the contract,[41] which, within the framework of the CISG, should be understood as a remedy of last resort.[42] This is illustrated by the fact that the buyer has a significant number of remedies available to him under the CISG in case of non-performance, set forth in Articles 45 to 52 CISG, such as the right to claim damages (Article 45 CISG), the right to demand specific performance (Article 46(1) CISG), delivery of substitute goods (Article 46(2) CISG), the right to repair (Article 46(3) CISG) or a reduction of the purchase price (Article 50 CISG). A similar set of remedies is available to the seller in case the buyer fails to perform any of his obligations. They are set forth in Articles 61 to 65 of the CISG.
The origins of fundamental breach can be found in Article 10 ULIS, which was drafted with the aim of preventing avoidance of the contract by one of the contracting parties based on inconsequential contractual breaches.[43] Its successor, Article 25 CISG, contains many ambiguous terms for which the Convention offers no clarification. These include terms such as: 'substantially to deprive', 'entitled to expect', 'did not foresee' and 'reasonable person of the same kind in the circumstances', which might make it more difficult to correctly interpret the concept of fundamental breach.[44] In this section an attempt is made to define the concept of fundamental breach under the CISG. [page 24]
4.3.1. Substantial Deprivation
In order for a breach to be fundamental under the CISG, it must cause a 'detriment' to the aggrieved party. When considering such a detriment, it is important to bear in mind that the preservation of the contract and ensuring that both parties receive what was promised to them under the contract are important incentives under the CISG. The Secretariat's Commentary on the 1978 Draft states that '[t]he determination whether the injury is substantial must be made in light of the circumstances of each case, for example, the monetary value of the contract, the monetary harm caused by the breach, or the extent to which the breach interferes with other activities of the injured party.'[45] This is a criterion which looks to the harm suffered by the injured party. However, when compensation for damages can serve as a remedy for non-performance, this should be an indication of the fact that there is no detriment within the meaning of the CISG. What matters most in commercial relations are economic results and not the formal fulfilment of obligations.[46]
To constitute a fundamental breach, the detriment must be substantial. For instance, the Oberlandesgericht (Appellate Court) in Frankfurt held that:
'[a] breach of contract is fundamental when the purpose of the contract is endangered so seriously that, for the concerned party to the contract, the interest in the fulfilment of the contract ceases to exist as a consequence of the breach of the contract (and the party in breach of the contract was aware of this or should have been).'[47]
And, according to the Zivilgericht (Civil Court) in Basel, what is decisive is the importance of the interest which is affected by the breached term of the contract.[48] In other words, there will be a fundamental breach of contract by the defaulting party if a party fails to receive the essence of what he was entitled to expect according to the contract.[49] The focus is on the substantial deprivation of the contractual expectation of the aggrieved party.
4.3.2. Contractual Expectation
The concept of substantial deprivation is thus fused together with the concept of contractual expectation, since a detriment can be characterised as a fundamental breach only if the injured party has no further interest in accepting the performance of the contract. The expectations of the aggrieved party are qualified by such phrases as 'what he is entitled to expect under the contract' in Article 25 CISG, or 'what it was entitled to expect under the contract' under Article 7.3.1(2)(a) UNIDROIT Principles or Article 8:103(b) PECL. It must be stressed that the expectations of the aggrieved party have to be discernible from the contract. This element is quite evident in itself and is also contained in the element of foreseeability.[50]
4.3.3. Foreseeability
The criterion of foreseeability as set out in Article 25 CISG is meant to prevent parties from avoiding the contract because of a fundamental breach when the substantial detriment has occurred unforeseeably. Since it is unlikely that the party in breach will admit to foreseeing the detriment in question, the 'reasonable person standard' was introduced.[51] In order to prevent the other party from avoiding the contract, the party in breach has to show that it did not foresee the negative -- result, nor would a reasonable person of the same kind and under the same conditions have foreseen it.
The question arises as to the point in time at which the detrimental result should have been foreseeable; Article 25 CISG does not state whether foreseeability should be decided by the time the contract was formed, or when the breach took place. Some scholars argue that since the contractual terms establish the rights and obligations of the buyer and seller, the decisive time for when foreseeability is determined should be when the contract is entered into. If not, one party could provide the other with further information, thereby changing what was deemed to be a substantial interest and could now give rise to a fundamental breach.[52] Others disagree with this, arguing that if the notion of good faith is taken into account, consideration must be given to any information received by the party in breach after the contract was formed.[53]
In any event, where a contract expressly states that the performance of an obligation is of the essence, there will be little room for proving that the breach caused an unforeseeable detriment. Conversely, where a contract does not clearly state the importance of an obligation, the conduct of the party in breach may be interpreted with more tolerance.[54]
4.3.4. UNIDROIT Principles and PECL
The concept of fundamental non-performance referred to in Article 7.3.1 UNIDROIT Principles and Article [page 25] 8:103 PECL generally corresponds with the concept of fundamental breach referred to in Article 25 CISG. However, contrary to the CISG, Article 7.3.1(2) of the UNIDROIT Principles lists a number of circumstances which may lead to the conclusion that a particular breach of contract is fundamental.[55] For the discussion here it is especially Article 7.3.1(2)(b) UNIDROIT Principles [56] and Article 8:103(a) PECL [57] that are of importance in defining the concept of fundamental breach under the CISG. Both Article 7.1.3(2)(b) UNIDROIT Principles and Article 8:103(a) PECL stipulate that where the parties have expressly or implicitly agreed that strict compliance with the contractual terms is essential, any deviation from the obligations of the parties under the contract is to be regarded as a fundamental breach. This is in accordance with the principle of party autonomy, which allows the parties to determine the circumstances under which a breach of contract will be fundamental.
Contracting parties may in any part of their contract derogate from the requirements of Article 25 CISG, in line with Article 6 CISG (party autonomy), and thereby set their own standards as to what will be regarded as a fundamental breach under the contract. The CISG is not intended to interfere with the freedom of sellers and buyers to shape the terms of their transactions.[58] The principle of party autonomy thus requires that the nature of the contractual obligation -- for which strict compliance might be essential -- is taken into consideration. If a contract governed by the CISG requires strict compliance with an obligation of the buyer or seller, a minor deviation from the defined standard of performance may amount to a fundamental breach of contract.[59]
5. DEFECTIVE DOCUMENTS; FUNDAMENTAL BREACH
This article has thus far discussed the obligation of the seller to deliver documents that strictly comply with the terms of the letter of credit. It was shown that the letter of credit is a separate transaction from the sales contract. On the other hand, it cannot be disputed that, in order for the price to be paid, the documents required under a letter of credit need to be in conformity, because otherwise the bank will inevitably refuse to pay. To determine whether a buyer has the right to avoid the contract when the seller has breached his obligation to deliver conforming documents, the concept of fundamental breach was defined in section 4.
In making the avoidance of the contract available only in cases of fundamental breach, the CISG seems to deviate from commercial practices that allow parties to reject goods -- and more importantly, documents -- that fail to strictly conform to the contractual specifications, even if that discrepancy is of little practical significance.[60] This is a notion which has been taken into consideration (as was discussed in section 4.3) in the relevant provisions of the UNIDROIT Principles and the PECL, but cannot be found in any CISG provision. It is submitted that if the contract provides for payment by means of a letter of credit, this implies that the documents need to be 'clean' in every respect, otherwise the buyer can avoid the contract.[61] According to Schwenzer, this can be derived directly from Article 14(a) UCP 600.[62] Parties must have incorporated the UCP into their contract, as it is generally agreed upon [63] and is accorded in the UCP themselves (Article 1 UCP 600) that the UCP apply only when they are incorporated into the contract. However, Article 9(2) CISG provides that parties are generally bound by prevalent usages. The CISG gives express recognition to the fact that international sales contracts are concluded against a background of trade usages and practice. Strict compliance with documentary requirements may well fall within the scope of this category.[64] The UCP are in themselves a reflection of current international banking practice. Thus, even if parties did not incorporate the UCP into their contract, the principle of strict compliance was implicitly agreed upon when they decided upon payment by means of a letter of credit.
As regards documentary breach in general, the Secretariat's Commentary on the 1978 Draft [65] frankly admits that the concept of fundamental breach does not reflect the practice in documentary sales. It says:[66]
'The rule that the buyer can normally avoid the contract only if there has been a fundamental breach [page 26] of contract is not in accord with the typical practice under CIF and other documentary sales. Since there is a general rule that the documents presented by the seller in a documentary transaction must be in strict compliance with the contract, buyers have often been able to refuse the documents if there has been some discrepancy in them even if that discrepancy was of little practical significance.'
Thus the Secretariat's Commentary explicitly opens the door to principles which have their origin outside the CISG, such as the principle of strict compliance. Even though the CISG is drafted in such a way that questions concerning its provisions should first and foremost be answered within its own framework (Article 7 CISG), it is evident from the above quotation that regard is to be had to the nature of the sales contract and its typical trade practices as well.
This is illustrated by Article 7.3.1(2)(b) UNIDROIT Principles, which provides that consideration is to be given to whether strict compliance with the obligation which has not been performed is of the essence under the contract. Thus, it is not the actual gravity of the non-performance which is looked at, but the nature of the contractual obligation for which strict performance might be of the essence.[67] The same is true for Article 8:103(a) PECL, which stipulates that non-performance of an obligation is fundamental to the contract if 'strict compliance with the obligation is of the essence of the contract'. The PECL Comment states that the relevant factor is not the actual gravity of the breach, but the agreement between the parties that strict adherence to the contract is essential and that any deviation from the obligation goes to the root of the contract so as to entitle the other party to be discharged from its obligations under that contract. This agreement may be derived from either the express or implied terms of the contract.[68]
Thus, the contract may provide in specific terms that, in the event of any breach by a party, the other party may terminate the contract. The effect of such a provision is that every failure in the performance of the stipulated obligations is to be regarded as fundamental.[69] Requiring strict compliance with documentary obligations in a sales contract is thus desirable, as it is generally consistent with the requirement of strict compliance under letters of credit.[70] It seems reasonable that, when parties have agreed on payment by means of a letter of credit, they have impliedly agreed on strict compliance with the documents in the underlying sales contract, since that is the main principle governing the delivery of documents in such transactions. Where a contract of sale imposes both documentary obligations (through a letter of credit) as well as physical obligations (the delivery of the goods) on the seller, then it is up to the seller to perform both.[71] Article 30 requires the seller to 'deliver the goods [and] hand over any documents relating to them' and thus recognises that the contract may impose separate obligations in relation to goods and documents.
6. CONCLUSION
A breach of contract constitutes a fundamental breach within the meaning of the CISG when the breach results in 'such detriment to the other party as substantially to deprive him of that which he is entitled to expect under the [sales] contract.'[72] The concept therefore allows for and even requires that the commercial background be taken into account in assessing what the injured party was entitled to expect. Whether the failure to deliver documents that strictly comply with the terms of the letter of credit constitutes a' fundamental breach of the underlying contract can only be determined by asking what a buyer is entitled to expect under a sales contract. A buyer is entitled to expect to receive documents that are not only marketable, which non-conforming documents generally are not, but also documents that will effect payment of the purchase price by the bank.
It is suggested here that, while Article 25 CISG was undoubtedly intended as a general principle that would restrict the right to avoid the contract to cases of serious breach of the underlying contract only, one should also recognise that parties ought to be able to derogate from that principle. Where commercial circumstances require a right of avoidance for trivial breaches, Articles 6 and 9 CISG, read in conjunction with the relevant articles of the UNIDROIT Principles and the PECL, enable an interpretation of fundamental breach that includes types of breach that are generally not considered sufficiently serious to justify the avoidance of the contract. These provisions allow parties to exclude the application of the CISG and provide that other trade usages are incorporated into their contract of sale, such as the principle of strict compliance (Article 9(1) CISG), by means of the agreement on a letter of credit as the method of payment. A seemingly insignificant defect in the performance by one of the parties would constitute a fundamental breach if the parties have agreed to this in their sales contract. Where the parties clarify that a breach of a particular obligation should be treated as a fundamental breach, effect should be given to that intention. [page 27]
For letter of credit transactions it should be accepted that the delivery of non-conforming documents constitutes a fundamental breach, if the result of this breach is that the bank refuses to pay the price for the goods. The payment of the price is one of the buyer's core obligations. However, it is up to the seller to request the bank to pay. A failure to deliver conforming documents should not result in the buyer having to pay the purchase price himself, even if the seller delivers conforming goods. Payment by means of a letter of credit is one of the main agreements in the sales contract. If one party undermines such agreement, it is that party who will have to bear the consequences and not the other.
Thus, the nature of the contractual obligation is an important factor in the determination of a fundamental breach. The parties can agree, expressly or implicitly, that any breach of contract allows the other party to terminate the contract. The parties may have agreed that strict compliance with the contractual terms is essential, which would result in even the slightest deviation having to be regarded as a fundamental breach. It is suggested here that this also holds true when the contracting parties have not expressly agreed to include such a provision in the contract. The duty of strict compliance can also be inferred merely from the type of contract and its accompanying trade customs and usages. In any event, the particularities of document trading must be taken into account in the interpretation of Article 25 CISG. Letter of credit practice strongly suggests that if the parties have agreed to payment by means of a letter of credit, they have simultaneously agreed to apply the strict compliance principle to the delivery of documents in the underlying sales contract.
On the other hand, the buyer is not allowed to hinder the seller in the performance of his obligations under the contract. On the contrary, he has an implied obligation to reasonably cooperate with the seller in order to enable him to deliver the correct documents. In that same respect it should be noted that if parties have agreed on broader terms in their contract of sale than are reflected in the letter of credit, it may constitute a breach of contract on the buyer's side if he is asked for a waiver of certain discrepancies by the bank, but refuses to accept the documents stating that they are not in compliance with the terms of the letter of credit. If the documents are in fact in compliance with what the parties have agreed upon in their contract of sale this, in effect, would constitute a refusal to pay.
It is stressed here once again that one of the main principles of the CISG is the preservation of the contract. In letter of credit transactions as well, the avoidance of the contract is a remedy of last resort. Only after all else has failed should a buyer be entitled to avoid the contract. This decision should not be taken lightly. Both parties have, first and foremost, an obligation to uphold their end of the bargain and not to hinder the performance by the other party. [page 28]
FOOTNOTES
* PhD Researcher at the Molengraaff Institute for Private Law, Utrecht University.
1. A well-known exception is Art. 5 of the Uniform Commercial Code (United States). It is, however, limited to general provisions concerning letter of credit transactions.
2. G. Xiang and R.P. Buckley, 'The Unique Jurisprudence of Letters of Credit: its Origin and Sources', San Diego Int'l L. I. 91 (2003), 91.
3. Drafted by the ICC Banking Commission on Banking Technique and an important source of international banking practice. The latest version dates from 2007: ICC Publication No.600 (rev. 2006).
4. R. Goode, Commercial Law (London: Penguin Books, 2004), 951.
5. A. Mullis, 'Avoidance for Breach under the Vienna Convention: A Critical Analysis of some of the Early Cases', in Andreas and Jarborg (eds), Anglo-Swedish Studies in Law (Uppsala: Iustus Forlag, 1998), 344.
6. Goode, supra note 4, p. 957.
7. See generally, R. Jack, Documentary Credits (London: Butterworths, 2001); see also A.N. Oelofse, The Law of Documentary Letters of Credit in Comparative Perspective (Pretoria: Interlegal, 1997), 7-9.
8. Goode, supra note 4, p. 987.
9. Oelofse, supra note 3, p. 357.
10. J. Ramberg, International Commercial Transactions (2nd edn, Stockholm, 2000), 142.
11. Jack, supra note 7, No. 1.40.
12. F.P. de Rooy, Documentary Credits (Deventer: Kluwer, 1984), 116.
13. Ibid., pp. 117-118.
14. See for instance: United Trading Corporation SA and Murray - Clayton Ltd v. Allied Arab Bank, [1985] Lloyd's Rep. 554, at 560.
15. Seasoncar Far East v. Bank Markazi Jomhouri Islami Iran, 1 Lloyd's Rep. 236 (1993).
16. Equitable Trust Co. v. Dawson Partners Ltd., 27 Lloyds' List L.R. 49, 52 (H.L. 1927).
17. Art. 14(a) imposes on the banks a duty to examine documents in order to: 'determine, on the basis of the documents alone, whether or not the documents appear on their face to constitute a complying presentation'.
18. Jack, supra note 7, No. 8.47.
19. Art. 14(d) UCP 600.
20. Jack, supra note 7, No. 8.48.
21. UNCITRAL website on the status of the CISG. This page is updated whenever the UNCITRAL Secretariat is informed of changes in the status of the Convention. See: <http://www.uncitral.org/uncitral/en/uncitral-texts/sale-goods/1980CISG-status.html>.
22. See Art. 6 CISG. Party autonomy under the CISG will be discussed in section 4.3.
23. Ibid., pp. 125-126.
24. J.O. Honnold, Uniform Law for International Sales under the 1980 United Nations Convention (The Hague: Kluwer Law International, 1999), para. 5, p. 6.
25. F. Enderlein and D. Maskow, International Sales Law (Oceana Publications, 1992), 9.
26. P. Huber, 'Some Introductory remarks on the CISG', Internationales Handelsrecht 6 (2006), 228-238.
27. P. Schlechtriem, in P. Schlechtriem and I. Schwenzer, Commentary on the UN Convention on the International Sale of Goods (Oxford: Oxford University Press, 2005), Art. 7, No. 12.
28. UNIDROIT Principles for International Commercial Contracts, 2004, available online at: <http://www.unidroit.org/english/principles/contracts/main.htm>.
29. Principles of European Contract Law, 1999, available online at: <frontpage.cbs.dk/law/commission_on_european_contract_law/>.
30. See for instance: P. Schlechtriem, in Schlechtriem/Schwenzer, supra note 27, Art. 7 No. 30; M.J. Bonell, 'The UNIDROIT Principles and the CISG', in An International Restatement of Contract Law (Irvington, NY: Transnational, 1997). A.M. Garro, 'The Gap-Filling Role of the UNIDROIT Principles in International Sales Law: Some Comments on the Interplay between the Principles and the CISG', Tulane Law Review 69 (1995), 1149-1190.
31. Huber, supra note 26, p. 234.
32. UNCITRAL Digest on Art. 54, available online at: <http://www.uncitral.org/uncitral/en/case-law/digests/cisg.html>.
33. For instance: Honnold, supra note 24, para. 323, p. 352; Enderlein/Maskow, supra note 25, p. 205.
34. See ICC award No.7585, France, 1992, in UNILEX; ICC award No. 7197 , France, 1992, in UNILEX; CLOUT case No.176 Austria, Oberster Gerichtshof (Supreme Court) 6 February 1996, available online at: <http://cisgw3.law.pace.edu/cases/960206a3.html>.
35. Art. 30: 'The seller must deliver the goods, hand over any documents relating to them and transfer the property in the goods, as required by the contract and this Convention.'
Art. 34: 'If the seller is bound to hand over documents relating to the goods, he must hand them over at the time and place and in the form required by the contract. If the seller has handed over documents before that time, he may, up to that time, cure any lack of conformity in the documents, if the exercise of this right does not cause the buyer unreasonable inconvenience or unreasonable expense. However, the buyer retains any right to claim damages as provided for in this Convention.'
36. I. Schwenzer, 'The Danger of Domestic Preconceived Views with Respect to the Uniform Interpretation of the CISG: The Question of Avoidance in the Case of Nonconforming Goods and Documents', Victoria University of Wellington Law Review 36:4 (2005), 805.
37. For a similar view, see the following court decisions: Germany, Oberlandesgericht Koblenz, 31 January 1997, UNILEX; Switzerland, Handelsgericht Zurich (Commercial Court), 26 April 1995, CLOUT case No.91. For the opposing view, however, see L. Graffi, 'Case Law on the Concept of "Fundamental Breach" in the Vienna Sales Convention', Revue de droit des affaires internationales/international Business Law Journal 3 (2003), 343.
38. C.M. Bianca and M.J. Bonell, Commentary on the International Sales Law: The 1980 Vienna Sales Convention (Milan: Guiffre, 1987), Art. 7, No. 2.3.2.2.
39. Schwenzer, supra note 36, p. 801.
40. Arts 49 and 25 CISG.
41. Arts 49(1)(a) and 64(1)(a) CISG.
42. R.A. Hillmann, 'Applying the United Nations Convention on Contracts for the International Sale of Goods: The Elusive Goal of Uniformity, in Review of the Convention on Contracts for the International Sale of Goods (CISG)', Cornell Int'l. L.J. 21 (1995), 30.
43. Bianca/Bonell, supra note 38, p. 206.
44. R. Koch, 'The Concept of Fundamental Breach of Contract under the United Nations Convention on Contracts for the International Sale of Goods (CISG)', in Pace Review of the Convention on Contracts for the International Sale of Goods (CISG), (The Hague: Kluwer Law International, 1999), 185.
45. See Secretariat Commentary on 1978 Draft Art. 23 (draft counterpart of CISG Art. 25), Comment 3; available at: <http://www.cisg.law.pace.edu/cisg/text/secomm/secomm-25.html> .
46. Enderlein/Maskow, supra note 25, p. 113.
47. See Oberlandesgericht (Appellate Court) Frankfurt, Germany, 17 September 1991; No.5 U 164/90, NJW 1992, pp. 633-635, English translation from Journal of Law and Commerce 12 (1993), 261.
48. See Zivilgericht (Civil Court) Basel-Stadt, Switzerland, 1 March 2002; No. p 1997/482; available at: <http://cisgw3.law.pace.edu/cases/020301s1.html>.
49. See Landgericht (District Court) Saarbrücken, Germany, 2 July 2002; No.80 49/02, Internationales Handelsrecht 1 (2003), 27-28.
50. See Enderlein/Maskow, supra note 25, p. 115.
51. A. Lorenz, 'Fundamental Breach under the CISG', 1998, available at: <http://cisgw3.law.pace.edu/cisg/biblio/lorenz.html> .
52. Ibid.
53. Graffi, supra note 37, p. 338.
54. Ibid.
55. Official Comments to the articles of the UNIDROIT Principles (2004 edition); see Comment 3 on Art. 7.3.1 UNIDROIT Principles.
56. Art. 7.3.1. (2)(b): 'In determining whether a failure to perform an obligation amounts to a fundamental nonperformance regard shall be had, in particular, to whether: ... (b) strict compliance with the obligation which has not been performed is of essence under the contract.'
57. Art. 8:103 PECL reads: 'A non-performance of an obligation is fundamental to the contract if: (a) strict compliance with the obligation is of the essence of the contract.'
58. Honnold, supra note 24, at para. 74, p. 77.
59. H. El-Saghir, 'Fundamental breach: Remarks on the manner in which the Principles of European Contract Law may be used to interpret or supplement Art. 25 CISG', July 2000, available online at: <http://www.cisg.law.pace.edu/cisg/text/peclcomp25.html>.
60. J. Yovel, 'Seller's Right to Avoid the Contract in International Transactions: Comparative Analysis of the Respective Provisions in the CISG (Art. 64) and in the PECL', June 2005, available at: <http://cisgw3.law.pace.edu/cisg/biblio/yovel64.html>.
61. Schwenzer, supra note 36, p. 805.
62. Ibid., p. 805; Schwenzer refers to Art. 13(a) of a previous version of the UCP (UCP 500, 1993 revision).
63. See e.g. Goode, supra note 4, pp. 968-969.
64. J. Yovel, 'Buyer's right to avoid the contract: Comparison between provisions of the CISG (Art. 49) and the counterpart provisions of the PECL (Art. 9:301,9:303 and 8:106)', June 2005, available at: <http://www.cisg.law.pace.edu/cisg/biblio/yove149.html>.
65. Commentary on the 1978 Draft Convention on Contracts for the International Sale of Goods (UN DOC. A/CONF. 97/5), available online at: <http://www.cisg.law.pace.edu/cisg/text/secomm/>.
66. On draft Art. 45 at para. 7.
67. See Comment 3(b) on Art. 7.3.1 UNIDROIT Principles, supra note 55.
68. Ole Lando & Hugh Beale (eds), Principles of European Contract Law; Parts I and II (The Hague; Kluwer Law International, 2000), Comment and Notes to Art. 8:103 PECL, 372-377.
69. Ibid., Comment B.
70. In S.I.A. T di dal Ferro v. Tradox Overseas SA [1980] 1 Lloyds Rep. 53 at 62, Megaw L.J. asked rhetorically whether it is desirable or defensible to distinguish between documentary obligations under sales contracts and under letters of credit.
71. Mullis, supra note 5, p. 346. 72. Art. 25 CISG.
