Controversy is brewing over a revision of legal guidelines that bankers say could destroy letters of credit.

Both bankers and lawyers have called for clarification of the legal code because of increasing litigation over the instruments, which are used widely to finance international trade.

At the end of 1992, about 100 lawsuits regarding letters of credit were pending in the United States.

But now bankers say the most recent draft of the commercial law ignores common banking practice, and differs from the international guidelines that have been established by bankers. As a result, the U.S. bankers say, the draft law, if adopted, would put U.S. law out of harmony with standard practice in the rest of the world.

Half of Exports

Banks issue letters of credit to guarantee the payment of a customer's drafts up to a stated amount, for a stated period. Half of all exports outside the U.S. are financed by letters of credit.

At the end of last year, the 300 largest bank issuers had a total of $169 billion of letter of credit obligations outstanding, according to Letter of Credit Update, a newsletter published by the International Chamber of Commerce.

The National Conference of Commissioners on Uniform State Law, the body that is drafting the law, called Uniform Commercial Code Article 5, plans to meet next week to put together its eighth draft of the law.

It's Up to the States

Once a draft is approved by the conference, it will be put before state legislatures for adoption state by state.

The conference took back the seventh draft in August, under duress from the bankers. "We told them we would fight this in every state legislature in the country," said Dan Taylor, president of the U.S. Council on International Banking Inc.

Bankers hope the new draft will take into consideration their concerns, which the U.S. Council on International Banking outlined in a 40-page study this spring.

The most recent draft included "revisions that would put the U.S. banking community out of step with the rest of the world," said Boris Kozolchyk, president of the National Law Center for Inter-American Free Trade, based in Tucson. "It could jeopardize the finality of payments."

More Risk for Banks Seen

Bankers say the draft law puts U.S. banks at greater risk should a letter of credit arrangement fall through than existing law does.

The study criticizes a number of points in the draft law. The bankers say that the provision of special warranties for beneficiaries of letters of credit call into question the viability of the entire market.

The study states: "The reputation of U.S. bank letters of credit will be put at risk if U.S. law is unique in providing that honor of a letter of credit is not final ... and that the proper law and forum for deciding disputes ... may be avoided by bringing a letter of credit warranty action. ..."

Treatment of Forgeries

The U.S. Council's study also criticizes the treatment of forged letters of credit in the draft law.

The draft sections would change existing law, and "would in many cases reward egregious wrongdoing...It would require honor of fraudulent documents where the beneficiary does not know of the fraud."

Conversely, the document says that existing U.S. law is "reasonably balanced."

Overall, "we believe the code should be skeletal and should not deal with operational issues," said Mr. Kozolchyk.

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.