Author: Jhanvi Panday, student of University of Lucknow
To the Point
In a globalised economy, letters of credit are lifelines for cross-border trade. But what happens when a bank backs out from its commitment? The Supreme Court in Union Bank of India v. Seppo Rally Oy laid down the legal sanctity of letters of credit, clarifying a bank’s absolute liability once such a credit instrument is issued. The case is a cornerstone in understanding the irrevocable nature of these instruments and the limited defences available to banks.
Use of Legal Jargon
A letter of credit (LC) is a document issued by a bank guaranteeing payment to a seller on behalf of the buyer, provided specific conditions are met. The issuing bank’s obligation under the LC is considered independent and absolute, separate from the underlying contract between the buyer and seller. Any wrongful dishonour can attract liability for breach of contract, wrongful dishonour, or negligence in performance of financial obligation.
The Proof
In this case, Seppo Rally Oy, a Finnish company, had entered into a trade contract with a party in India. As part of the transaction, Union Bank of India issued a confirmed letter of credit in favour of Seppo Rally Oy. Despite the presentation of documents being in compliance with the LC terms, the bank refused to honour the payment. Seppo filed a suit claiming damages for non-payment, alleging breach of the absolute obligation under the LC.
The Bank’s defence was centred on the argument that there were defects in the underlying contract between the Indian buyer and Seppo Rally Oy, but the Court rejected this, reaffirming that a bank’s obligation under a letter of credit is autonomous
Abstract
The Supreme Court held that:
- A letter of credit is independent of the main contract.
- The bank has no right to refuse payment merely because there are disputes between the buyer and seller.
- Unless fraud is alleged and proven, or there is documentary non-compliance, the bank must honour its commitment.
The Court emphasised that allowing banks to backtrack on LCs would shake the very foundation of international trade, where these instruments are seen as trust-based financial guarantees.
Case Laws
- United Commercial Bank v. Bank of India, AIR 1981 SC 1426: The Court ruled that a bank’s obligation under a letter of credit is absolute and not affected by disputes in the primary contract.
- U.P. Co-operative Federation Ltd. v. Singh Consultants, (1988) 1 SCC 174: Recognised the fraud exception in LCs, where payment can be denied if there is clear evidence of fraud.
- Centax (India) Ltd. v. Vinmar Impex Inc., (1986) 4 SCC 136: Reiterated that in international business, sanctity of LCs must be protected.
Conclusion
The judgment in Union Bank of India v. Seppo Rally Oy serves as a powerful reminder that a letter of credit is not just a piece of paper — it’s a binding commitment. Banks cannot escape their obligations unless they prove fraud or non-compliance on the face of documents. The case strengthened India’s standing in global trade by upholding the principles of certainty, reliability, and enforceability in banking practices.
For law students, bankers, and traders alike, this case remains a go-to precedent for understanding how Indian courts treat cross-border credit instruments.
FAQs
Q1. What is the significance of this case in banking law?
Ans. It clarified that banks issuing letters of credit cannot dishonour them without valid legal reasons like fraud or document mismatch.
Q2. Can a bank be sued for not honouring a letter of credit?
Ans. Yes, as seen in this case, banks can be held liable for damages due to wrongful dishonour.
Q3. Is a letter of credit linked to the main contract between buyer and seller?
Ans. Legally, no. The LC is considered independent, and the bank’s duty arises from the LC, not the sale contract.
Q4. Does this case apply to domestic LCs too?
Ans. While primarily about international trade, the legal principles are equally valid for domestic letters of credit.
