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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 [*]

1. Introduction2. Letters of Credit3. Doctrine Concerning the Letter of Credit Transaction

3.1 The Principle of Independence 3.2 The Principle of Strict Compliance

4. Fundamental Breach in Terms of the CISG 4.1 The CISG as the Relevant Law Governing the Sales Contract 4.2 Principal Obligations of the Buyer and the Seller under the CISG 4.3 The Definition of Fundamental Breach 4.3.1 Substantial Deprivation 4.3.2 Contractual Expectation 4.3.3 Foreseeability 4.3.4 UNIDROIT Principles and PECL

5. Defective Documents: Fundamental Breach?6. Conclusion

1. INTRODUCTION

International commercial contracts, such as international sales of goods, often involve large sums ofmoney and large shipments of goods. Ever present and inherent to any commercial contract, butespecially international transactions, is the threat of non-payment by the buyer or non-performance bythe seller. Parties may not know much about each other, in particular about the financial stability andtrustworthiness of their trading partner. The problem is compounded by uncertainty surrounding theapplicable national law, where parties have not made an explicit choice of law in their contract. Andeven if a national law is chosen by the parties, at least one of the contracting parties will have to dealwith a legal system that is not his own. The potential costs, inconvenience and delay involved inpursuing a recovery case against a buyer for non-payment or against a seller for non-delivery maywell 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 aninternational sale, however, this scenario is highly unlikely, as the risks inherent to such a transactionwould be too great. In such situations, when suppliers or vendors are selling and purchasing goods toand from overseas customers with whom they have not established a business relationship, partiestend to search for additional means of securing performance and payment beyond the mere agreementin the contract. Such security may be achieved by means of, for instance, a letter of credit. Theinvolvement of banks in international sales increases the costs of the transactions, but minimises theelement of risk.

When contracting parties have agreed to effectuate payment by means of a letter of credit, the buyer'sbank takes upon itself the obligation to pay the purchase price when the seller tenders the documentsthat are stipulated in the letter of credit. The bank has no knowledge of the underlying contract or ofthe actual goods that are traded. The documents must therefore comply strictly with the terms of thecredit. In most national legal systems there is no such thing as a letter of credit law.[1] As such, theprinciple of strict compliance has evolved from international banking practice.[2] Article 14 of the

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Uniform Customs and Practice for Documentary Credits (UCP 600)[3] holds important provisionsconcerning the application of the principle of strict compliance to the tender of the documents by theseller. 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 subjectto the UCP.[4]

This article examines whether a failure to deliver documents conforming to the terms of the letter ofcredit can constitute a fundamental breach of the underlying sales contract as defined by Article 25 ofthe Vienna Sales Convention (CISG) by the seller, and thereby enable the buyer to avoid the contractentirely (Article 49 CISG). In order for a buyer or a seller to avoid a contract under the CISG, thebuyer or seller must prove that the breach is fundamental. Obviously, this will depend on theseriousness of the breach in question. And this, in turn, depends on the type of contract. It is perhapsin relation to the delivery of documents that the concept of fundamental breach is likely to cause mostproblems.[5] In a letter of credit transaction, payment is effected by the tender of conformingdocuments by the seller to a bank. Moreover, the documents represent the goods that are shipped tothe buyer. The delivery of non-conforming documents might mean the delivery of non-conforminggoods. 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 paymentis effected through a letter of credit. However, before the main question in this article -- whether thefailure to deliver conforming documents can constitute a fundamental breach -- can be considered, theexceptional character of letter of credit transactions must [page 19] be understood. This will bediscussed in the following section. In section 3 the two fundamental principles governing the letter ofcredit transaction -- the principle of independence and the principle of strict compliance -- areconsidered. The concept of fundamental breach as set forth in Article 25 CISG will be discussed insection 4. Finally, in section 5, it is submitted that the underlying sales contract can indeed be affectedby the fact that parties have agreed to the payment of the purchase price through a letter of credit. Anessential part of a letter of credit transaction is the delivery of the documents, as this directly effectsthe payment of the purchase price. A failure to deliver documents that strictly comply with the termsof 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 ofcontract 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, wherebya bank (the issuing bank) acts at the request and on the instructions of a customer (thebuyer/applicant) to make a payment to a third party (the seller/beneficiary) against stipulateddocument(s), provided that the terms and conditions of the credit are complied with. Once the buyerhas 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 (thebeneficiary). The buyer, as the applicant, will inform the issuing bank of the documentaryrequirements that it wishes to have inserted into the letter of credit. The issuing bank usually has itsplace of business in the buyer's country, whereas the seller operates from another country. Thereforethe issuing bank may request a bank in the seller's country (which can be a branch office of the issuingbank) 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 againstreimbursement.

All conditions stipulated in the letter of credit have to be documentary conditions. If a letter of creditcontains conditions without stating the document(s) to be presented in compliance therewith, bankswill deem such conditions as not stated and will disregard them (see Article 14h UCP 600). In otherwords, the buyer cannot require that the seller prove a fact that is not capable of being recorded in adocument. All that he can require the seller to do is to submit documentation that records certain factsor conditions.

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The bank's promise to pay is conditional upon the seller presenting evidence that the goods have beenshipped to the port of destination, along with the other documents required by the sales contract andthus stipulated in the letter of credit. With regard to the payment mechanism, the whole transaction isbased purely on documentation that the bank checks for compliance against the letter of credit; thedocuments are deemed to represent the goods. The result is that neither party to the transactioncontrols both the goods and the money at the same time. These requirements are essentially designedto ensure that the seller submits documentation that records its compliance with its obligations underthe underlying sales agreement,[7] as well as to restrict the bank's involvement to the examination ofthe 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 andinternational banking practice. The principles that are deemed to be the most important in letter ofcredit law are the principle of independence and the principle of strict compliance. Their developmentand 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 thespecifics and the actual performance of the underlying contract. The conditions of the bank's duty topay are to be found exclusively in the terms of the letter of credit and do not in any way depend on theperformance of the seller's obligations under the contract of sale.[8] Article 4(a) UCP 600 stipulatesthat:

'[a] credit by its nature is a separate transaction from the sale or other contract on which it maybe based. Banks are in no way concerned with or bound by such a contract, even if anyreference whatsoever to it is included in the credit. ...'

Accordingly, when deciding whether to make payment under the credit in favour of a beneficiary, thebank may only look at the terms of the credit itself. The bank may not raise any defences that areavailable to the applicant in respect of the underlying agreement of sale.[9] The seller will thus alwaysreceive payment from the bank if he submits documents that comply with the credit, regardless of anydevelopments in the underlying sales agreement. The bank should not be forced into the position inwhich it has to resolve disputes between the seller and buyer, because this would lead to extensivedelays 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 ofcredit 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 whentendering the documents. As De Rooy [12] has stated: 'No system can be effective if it is blind tosomething which is manifestly unreasonable.' If the bank discovers fraud in the documents that weretendered by the beneficiary, it is entitled to refuse payment even though the documents appear to be inconformity with the terms of the letter of credit. This entails that the beneficiary, if he had beentruthful in his representations, would have tendered documents that did not strictly comply with theterms of the letter of credit. The fraud, however, must be clear and evident to the bank, without theneed for additional proof or having to investigate the actual circumstances surrounding the underlyingcontract.[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 hastendered 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

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independence. If the seller wishes to be paid under the letter of credit transaction, documents whichstrictly comply with the terms of the letter of credit must be tendered. The doctrine of strictcompliance demands that the bank's verification of the documents upon presentation is both literal andexact. When applying the principle of strict compliance in its strictest sense, even the most trivialdiscrepancy 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 Sumnerstated 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 takeupon 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 atits own risk.'[16]

This decision has laid the groundwork for a long line of court rulings all over the world -- especiallyin the United Kingdom and the United States -- defining, refining and redefining the principle of strictcompliance.

The UCP are fairly general in providing for a standard of documentary compliance and make nomention of the principle of strict compliance as such. However, Article 14(a) UCP 600 requiresdocuments to 'appear on their face to be in accordance with the terms and conditions of the credit'. Intune with the doctrine of independence, Article 14(a) of the UCP 600 further provides that banks mustmake their checks 'on the basis of the documents alone'.[17] In this respect, the principle of strictcompliance is linked to the independence principle. Banks act on behalf of the buyer within the limitsdelineated in the letter of credit alone. Whenever they go beyond these limits, the buyer can reject thebank'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 hasadded to the requirement of strict compliance that the documents do not need to be identical, but mustnot be in conflict with each other:

'Data in a document, when read in context with the credit, the document itself and internationalstandard banking practice, need not be identical to, but must not be in conflict with data in thatdocument, any other stipulated document or the credit.'[19]

Thus, subject to the UCP, banks cannot reject every document containing a misspelling ortypographical error. In fact, banks are obliged to examine whether the documents that are tendered ina letter of credit transaction are in conformity with the credit not by determining merely whether theycomply exactly to the terms of the credit, but whether they are consistent with each other, and asimple misspelling usually will not affect such consistency. Article 18(c) UCP 600 specificallystipulates that only the commercial invoice must contain a description of the goods that strictlyconforms to the description in the letter of credit, whereas the other documents may contain a moregeneral description, as long as this description is not inconsistent with the credit and the otherdocuments (see Article 14(e) UCP 600).

Of course, it is of great importance that the description of the goods is clearly identifiable as thedescription in [page 21] the credit and that it is kept simple.[20] This remains the best method toavoid complications in the examination of the documents and to achieve the main goal of the letter ofcredit transaction and its strict compliance principle: to provide a secure payment mechanism.

4. FUNDAMENTAL BREACH IN TERMS OF THE VIENNA CONVENTION FOR THE INTERNATIONALSALE OF GOODS

This article seeks to answer the question of whether non-compliance by one of the contracting partieswith the terms of the letter of credit can constitute a fundamental breach of contract within themeaning of Article 25 CISG. For a proper discussion of the subject in this section, after a brief

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introduction to the CISG itself, the scope and meaning of the term 'fundamental breach' will beexamined.

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 ofpreparatory work by UNCITRAL, was adopted in April 1980 at the United Nations DiplomaticConference attended by sixty-two States. It later entered into force in January 1988, and todayseventy-three countries are party to the Convention.[21] The CISG provides uniform rules forcontracts for the international sale of goods. It governs both the formation of international salescontracts and provides the substantive law governing international sales in one concise document. Inresponse to the problems resulting in the need for international unification, the CISG not only avoidsthe potential difficulties as to the choice of applicable law, but also offers parties a framework inwhich 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 internationalsale of goods.[23] It was designed specifically to promote the progressive harmonisation andunification of international trade law [24] and to create a uniform international sales law [25] It thusreflects many general principals of contract law, even though the CISG is not necessarily the commondenominator of an exercise in comparative law, but the result of a political negotiation process thatwas 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 partlyachieved, with the CISG being an important step in this process. However, these objectivespresuppose that these provisions for international sales contracts will be given a uniform, neutral andinternationally focused interpretation. Accordingly, Article 7(1) requires that the CISG be interpreteduniformly. The first guideline is its international character. In the first place, therefore, the CISG hasto be interpreted autonomously. This means that the terms of the CISG should not simply be regardedas having the same meaning as identical terms that may exist in a domestic legal system. Recourse todomestic principles is not allowed.

The second guideline is the need to promote uniformity in the application of the CISG. A newautonomous method of interpretation is developed with the aid of case law and practice. The courtsshould try to take into account foreign case law (and academic writing) as persuasive authority wheninterpreting the CISG.[27] In fact, the relevant material is made available by several. databases andpublications which are easily accessible, so that there is at least a reasonable basis for complying withthe uniformity guideline. Article 7 CISG also points to the application of good faith in internationaltrade. Good faith as a principle is not only applied to the interpretation of the CISG as a whole, but italso regulates the behaviour of the parties.

Where appropriate, use is made of the UNIDROIT Principles for Commercial Contracts (UNIDROITPrinciples) [28] and the Principles of European Contract Law (PECL) [29] to interpret the relevantprovisions of the CISG. It is still a somewhat controversial issue as to whether such principles may beused for 'gap-filling' under Article 7(2) CISG, although there are many legal authors who promote thisidea.[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 internationaluniform law instruments. However, Article 7(2) CISG makes it clear that gaps in the CISG have to befilled by using first and foremost the general principles which are to be found within the CISG. Thisdoes not mean, however, that the UNIDROIT Principles cannot play any role in the gap-fillingprocess: they can be used to corroborate a principle that has already been deduced from the CISGitself.[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

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as set out in Articles 53 and 54 CISG. The general obligations of the buyer are summed up in Article53, which restates in very broad language that the buyer must pay the price for the goods and takedelivery thereof as required under the contract and the CISG. This duty to pay the price is furtherspecified in Article 54 CISG, which provides that:

'[t]he buyer's obligation to pay the price includes taking such steps and complying with suchformalities as may be required under the contract or any laws and regulations to enable paymentto be made.'

These steps can include, as mentioned in the UNCITRAL Digest [32] and in a number of scholarlyopinions,[33] the opening of a letter of credit, the establishment of security or obtaining a bankguarantee, 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 ofsale that payment shall be effected by the furnishing of a letter of credit, it puts the buyer under anobligation to have such a letter of credit opened by a bank in favour of the seller. This is a conditionprecedent 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, whichmay 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 overany documents relating to the goods as set out in Articles 30 and 34 CISG.[35] Article 34 of the CISGprovides (in part) that:

'[i]f the seller is bound to hand over documents relating to the goods, he must hand them over atthe 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 ofgoods (Article 35 CISG), a failure to deliver conforming documents in a documentary sales contractamounts 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 credittransaction, this may also imply that the tender of non-conforming documents to the bank by the sellerunder the letter of credit constitutes a breach of contract. It must be noted, however, that both theCISG -- and the UCP provide for the possibility to re-tender the documents that were previouslyconsidered 'unclean'. Article 34 CISG grants this possibility without any further requirements otherthan that the seller needs to cure the defects within the time allowed by the sales contract, i.e. withinthe time allowed by the letter of credit. Thus, it is not the tender of non-conforming documents itselfthat constitutes the breach of contract, but the failure to deliver conforming documents within the timespecified in the letter of credit.

Minor defects can be cured by the seller or excused by the buyer under Article 16(c) UCP 600, whichstipulates that the bank will notify the seller of any discrepancies in the documents within fivebanking days. If the letter of credit has not yet expired the seller may re-tend the documents. If there isa serious offer to cure the defects in the documents -- within a reasonable time -- a fundamentalbreach does not occur and the buyer does not have the right to terminate the contract.[37] If thediscrepancies in the documents do not affect the representation of the goods, the bank may alsocontact 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 thatunder the CISG, parties ought to cooperate, Thus, even though under the UCP, a duty to waiveirrelevant discrepancies does not exist, this may be different under the CISG despite the fact that theletter of credit is strictly separate from the underlying agreement (see section 3.1). The principle ofindependence is intended to prevent banks from having to investigate the facts of the underlyingcontract. Such protection is not appropriate where the parties to the underlying sales contract areconcerned. The buyer and seller are fully aware of what was agreed upon in the contract, or at leastare deemed to be. If a buyer knows that certain discrepancies will not have any effect on the delivery

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of the goods, it is submitted that he has an obligation under the CISG, based on the principle of goodfaith, to waive those discrepancies, The UNIDROIT Principles expressly state that contractualobligations may be implied under the maxim of good faith in Article 5.2. Moreover, Article 5.1.3UNIDROIT 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 doesnot contain a comparable rule. Nevertheless, it is widely accepted that under the CISG, additionalobligations 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 anadditional opportunity to cure the defective goods and/or documents, This is, however, only possibleif the seller can do so without unreasonable delay or inconvenience to the buyer.[39] It is submittedthat in a letter of credit transaction such an opportunity is generally not available to the seller. Oncethe letter of credit has expired, the seller cannot re-tender the documents to cure any previous defectsto effect payment under the credit. Clean documents may still be of value to the buyer in that theyrepresent the goods, but payment can no longer be effected through the agreed letter of credit, as wasagreed 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 thebreach was fundamental.[40]

The tender of strictly complying documents in order to effect payment under the letter of credit is asignificant part of the sales contract. The bank is obliged to refuse to pay the price when thedocuments do not comply with the terms stipulated in the letter of credit. This implies that the tenderof conforming documents is also an important part of the seller's obligations under the underlyingcontract. To establish whether the failure to comply with such an (implied) obligation under the salescontract constitutes a fundamental breach, consideration will here be given to the definition of afundamental breach under the CISG. The Convention defines a fundamental breach in Article 25CISG as follows:

'[a] breach of contract committed by one of the parties is fundamental if it results in suchdetriment to the other party as substantially to deprive him of what he is entitled to expect underthe contract, unless the party in breach did not foresee and a reasonable person of the same kindin the circumstances would not have foreseen such a result.'

The definition of the concept of fundamental breach must be clear, especially when one considers theimplications of a non-performance being defined as a fundamental breach: the buyer or seller willthen be able to avoid the contract,[41] which, within the framework of the CISG, should beunderstood as a remedy of last resort.[42] This is illustrated by the fact that the buyer has a significantnumber of remedies available to him under the CISG in case of non-performance, set forth in Articles45 to 52 CISG, such as the right to claim damages (Article 45 CISG), the right to demand specificperformance (Article 46(1) CISG), delivery of substitute goods (Article 46(2) CISG), the right torepair (Article 46(3) CISG) or a reduction of the purchase price (Article 50 CISG). A similar set ofremedies is available to the seller in case the buyer fails to perform any of his obligations. They are setforth 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 aimof preventing avoidance of the contract by one of the contracting parties based on inconsequentialcontractual breaches.[43] Its successor, Article 25 CISG, contains many ambiguous terms for whichthe Convention offers no clarification. These include terms such as: 'substantially to deprive', 'entitledto expect', 'did not foresee' and 'reasonable person of the same kind in the circumstances', which mightmake it more difficult to correctly interpret the concept of fundamental breach.[44] In this section anattempt is made to define the concept of fundamental breach under the CISG. [page 24]

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4.3.1. Substantial Deprivation

In order for a breach to be fundamental under the CISG, it must cause a 'detriment' to the aggrievedparty. When considering such a detriment, it is important to bear in mind that the preservation of thecontract and ensuring that both parties receive what was promised to them under the contract areimportant 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 ofeach 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 acriterion which looks to the harm suffered by the injured party. However, when compensation fordamages can serve as a remedy for non-performance, this should be an indication of the fact that thereis no detriment within the meaning of the CISG. What matters most in commercial relations areeconomic results and not the formal fulfilment of obligations.[46]

To constitute a fundamental breach, the detriment must be substantial. For instance, theOberlandesgericht (Appellate Court) in Frankfurt held that:

'[a] breach of contract is fundamental when the purpose of the contract is endangered soseriously that, for the concerned party to the contract, the interest in the fulfilment of thecontract ceases to exist as a consequence of the breach of the contract (and the party in breachof 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 theinterest which is affected by the breached term of the contract.[48] In other words, there will be afundamental breach of contract by the defaulting party if a party fails to receive the essence of what hewas entitled to expect according to the contract.[49] The focus is on the substantial deprivation of thecontractual expectation of the aggrieved party.

4.3.2. Contractual Expectation

The concept of substantial deprivation is thus fused together with the concept of contractualexpectation, since a detriment can be characterised as a fundamental breach only if the injured partyhas no further interest in accepting the performance of the contract. The expectations of the aggrievedparty are qualified by such phrases as 'what he is entitled to expect under the contract' in Article 25CISG, or 'what it was entitled to expect under the contract' under Article 7.3.1(2)(a) UNIDROITPrinciples or Article 8:103(b) PECL. It must be stressed that the expectations of the aggrieved partyhave to be discernible from the contract. This element is quite evident in itself and is also contained inthe 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 avoidingthe contract because of a fundamental breach when the substantial detriment has occurredunforeseeably. Since it is unlikely that the party in breach will admit to foreseeing the detriment inquestion, the 'reasonable person standard' was introduced.[51] In order to prevent the other party fromavoiding the contract, the party in breach has to show that it did not foresee the negative -- result, norwould 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 beenforeseeable; Article 25 CISG does not state whether foreseeability should be decided by the time thecontract was formed, or when the breach took place. Some scholars argue that since the contractualterms establish the rights and obligations of the buyer and seller, the decisive time for whenforeseeability is determined should be when the contract is entered into. If not, one party couldprovide the other with further information, thereby changing what was deemed to be a substantialinterest and could now give rise to a fundamental breach.[52] Others disagree with this, arguing that if

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the notion of good faith is taken into account, consideration must be given to any information receivedby 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 inbreach 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 andArticle [page 25] 8:103 PECL generally corresponds with the concept of fundamental breach referredto in Article 25 CISG. However, contrary to the CISG, Article 7.3.1(2) of the UNIDROIT Principleslists a number of circumstances which may lead to the conclusion that a particular breach of contractis 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 fundamentalbreach under the CISG. Both Article 7.1.3(2)(b) UNIDROIT Principles and Article 8:103(a) PECLstipulate that where the parties have expressly or implicitly agreed that strict compliance with thecontractual terms is essential, any deviation from the obligations of the parties under the contract is tobe 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 befundamental.

Contracting parties may in any part of their contract derogate from the requirements of Article 25CISG, in line with Article 6 CISG (party autonomy), and thereby set their own standards as to whatwill be regarded as a fundamental breach under the contract. The CISG is not intended to interferewith the freedom of sellers and buyers to shape the terms of their transactions.[58] The principle ofparty autonomy thus requires that the nature of the contractual obligation -- for which strictcompliance might be essential -- is taken into consideration. If a contract governed by the CISGrequires strict compliance with an obligation of the buyer or seller, a minor deviation from the definedstandard 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 complywith the terms of the letter of credit. It was shown that the letter of credit is a separate transactionfrom 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 bankwill inevitably refuse to pay. To determine whether a buyer has the right to avoid the contract whenthe seller has breached his obligation to deliver conforming documents, the concept of fundamentalbreach was defined in section 4.

In making the avoidance of the contract available only in cases of fundamental breach, the CISGseems 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 isof little practical significance.[60] This is a notion which has been taken into consideration (as wasdiscussed in section 4.3) in the relevant provisions of the UNIDROIT Principles and the PECL, butcannot be found in any CISG provision. It is submitted that if the contract provides for payment bymeans 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 directlyfrom Article 14(a) UCP 600.[62] Parties must have incorporated the UCP into their contract, as it isgenerally agreed upon [63] and is accorded in the UCP themselves (Article 1 UCP 600) that the UCPapply only when they are incorporated into the contract. However, Article 9(2) CISG provides thatparties are generally bound by prevalent usages. The CISG gives express recognition to the fact thatinternational sales contracts are concluded against a background of trade usages and practice. Strict

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compliance with documentary requirements may well fall within the scope of this category.[64] TheUCP are in themselves a reflection of current international banking practice. Thus, even if parties didnot incorporate the UCP into their contract, the principle of strict compliance was implicitly agreedupon 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 documentarysales. It says:[66]

'The rule that the buyer can normally avoid the contract only if there has been a fundamentalbreach [page 26] of contract is not in accord with the typical practice under CIF and otherdocumentary sales. Since there is a general rule that the documents presented by the seller in adocumentary transaction must be in strict compliance with the contract, buyers have often beenable to refuse the documents if there has been some discrepancy in them even if thatdiscrepancy was of little practical significance.'

Thus the Secretariat's Commentary explicitly opens the door to principles which have their originoutside the CISG, such as the principle of strict compliance. Even though the CISG is drafted in sucha way that questions concerning its provisions should first and foremost be answered within its ownframework (Article 7 CISG), it is evident from the above quotation that regard is to be had to thenature 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 isto be given to whether strict compliance with the obligation which has not been performed is of theessence under the contract. Thus, it is not the actual gravity of the non-performance which is lookedat, 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 anobligation is fundamental to the contract if 'strict compliance with the obligation is of the essence ofthe 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 anydeviation from the obligation goes to the root of the contract so as to entitle the other party to bedischarged from its obligations under that contract. This agreement may be derived from either theexpress 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 otherparty may terminate the contract. The effect of such a provision is that every failure in theperformance of the stipulated obligations is to be regarded as fundamental.[69] Requiring strictcompliance with documentary obligations in a sales contract is thus desirable, as it is generallyconsistent with the requirement of strict compliance under letters of credit.[70] It seems reasonablethat, when parties have agreed on payment by means of a letter of credit, they have impliedly agreedon strict compliance with the documents in the underlying sales contract, since that is the mainprinciple governing the delivery of documents in such transactions. Where a contract of sale imposesboth documentary obligations (through a letter of credit) as well as physical obligations (the deliveryof the goods) on the seller, then it is up to the seller to perform both.[71] Article 30 requires the sellerto 'deliver the goods [and] hand over any documents relating to them' and thus recognises that thecontract 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 thebreach results in 'such detriment to the other party as substantially to deprive him of that which he isentitled to expect under the [sales] contract.'[72] The concept therefore allows for and even requiresthat the commercial background be taken into account in assessing what the injured party was entitledto expect. Whether the failure to deliver documents that strictly comply with the terms of the letter ofcredit constitutes a' fundamental breach of the underlying contract can only be determined by asking

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what a buyer is entitled to expect under a sales contract. A buyer is entitled to expect to receivedocuments that are not only marketable, which non-conforming documents generally are not, but alsodocuments 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 thatwould 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. Wherecommercial 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 aninterpretation of fundamental breach that includes types of breach that are generally not consideredsufficiently serious to justify the avoidance of the contract. These provisions allow parties to excludethe application of the CISG and provide that other trade usages are incorporated into their contract ofsale, such as the principle of strict compliance (Article 9(1) CISG), by means of the agreement on aletter of credit as the method of payment. A seemingly insignificant defect in the performance by oneof the parties would constitute a fundamental breach if the parties have agreed to this in their salescontract. Where the parties clarify that a breach of a particular obligation should be treated as afundamental 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 documentsconstitutes a fundamental breach, if the result of this breach is that the bank refuses to pay the pricefor the goods. The payment of the price is one of the buyer's core obligations. However, it is up to theseller to request the bank to pay. A failure to deliver conforming documents should not result in thebuyer having to pay the purchase price himself, even if the seller delivers conforming goods. Paymentby means of a letter of credit is one of the main agreements in the sales contract. If one partyundermines 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 afundamental breach. The parties can agree, expressly or implicitly, that any breach of contract allowsthe other party to terminate the contract. The parties may have agreed that strict compliance with thecontractual terms is essential, which would result in even the slightest deviation having to be regardedas a fundamental breach. It is suggested here that this also holds true when the contracting partieshave not expressly agreed to include such a provision in the contract. The duty of strict compliancecan 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 ofArticle 25 CISG. Letter of credit practice strongly suggests that if the parties have agreed to paymentby means of a letter of credit, they have simultaneously agreed to apply the strict compliance principleto 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 obligationsunder the contract. On the contrary, he has an implied obligation to reasonably cooperate with theseller in order to enable him to deliver the correct documents. In that same respect it should be notedthat if parties have agreed on broader terms in their contract of sale than are reflected in the letter ofcredit, it may constitute a breach of contract on the buyer's side if he is asked for a waiver of certaindiscrepancies by the bank, but refuses to accept the documents stating that they are not in compliancewith the terms of the letter of credit. If the documents are in fact in compliance with what the partieshave 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 thecontract. 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 notbe taken lightly. Both parties have, first and foremost, an obligation to uphold their end of the bargainand not to hinder the performance by the other party. [page 28]

FOOTNOTES

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* 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 ofinternational 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 theEarly 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 basisof the documents alone, whether or not the documents appear on their face to constitute a complyingpresentation'.

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 UNCITRALSecretariat is informed of changes in the status of the Convention. See:<http://www.uncitral.org/uncitral/en/uncitral-texts/sale-goods/1980CISG-status.html>.

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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 theInternational 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 UNIDROITPrinciples in International Sales Law: Some Comments on the Interplay between the Principles andthe 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, inUNILEX; 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 transferthe 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 overat the time and place and in the form required by the contract. If the seller has handed over documentsbefore that time, he may, up to that time, cure any lack of conformity in the documents, if the exerciseof 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 UniformInterpretation of the CISG: The Question of Avoidance in the Case of Nonconforming Goods andDocuments', Victoria University of Wellington Law Review 36:4 (2005), 805.

37. For a similar view, see the following court decisions: Germany, Oberlandesgericht Koblenz, 31January 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 affairesinternationales/international Business Law Journal 3 (2003), 343.

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38. C.M. Bianca and M.J. Bonell, Commentary on the International Sales Law: The 1980 ViennaSales 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 Saleof Goods: The Elusive Goal of Uniformity, in Review of the Convention on Contracts for theInternational 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 Conventionon Contracts for the International Sale of Goods (CISG)', in Pace Review of the Convention onContracts 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), Comment3; 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 U164/90, 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; availableat: <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 onArt. 7.3.1 UNIDROIT Principles.

56. Art. 7.3.1. (2)(b): 'In determining whether a failure to perform an obligation amounts to afundamental nonperformance regard shall be had, in particular, to whether: ... (b) strict compliancewith 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.'

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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 EuropeanContract 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 Analysisof 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, 1993revision).

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 (UNDOC. 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. askedrhetorically whether it is desirable or defensible to distinguish between documentary obligations undersales contracts and under letters of credit.

71. Mullis, supra note 5, p. 346. 72. Art. 25 CISG.

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