A Study on the Appropriate Way to Invoke Economic Sanctions as a Defense to Payments in Commercial Letters of Credit

Purpose - The purpose of this paper is to find an appropriate method for banks to use economic sanctions as a defense to payment in commercial letters of credit. Design/Methodology - This paper first explains the rules and principles fundamentally supporting the letter of credit’s commercial usefulness. Then, it explains how banks use economic sanctions as a defense to payment in the letter of credit, and what legal problems may accompany such use. Lastly, this paper suggests an appropriate way for banks to adopt a solution. Findings - The main problem with the practice of invoking economic sanctions as a defense to payment under the letter of credit stems from the fact that such practice would hurt the reliability of the letter of credit as a payment method due to the uncertainty of payment. Since such unpredictability occurs due to lack of clear guidance on the allocation of sanctions-related risks, it can be cured by having well-drafted sanctions clauses clearly allocating the risks accompanying the economic sanctions among parties to letters of credit. This paper suggests six criteria to be considered when evaluating whether an economic sanctions clause in a letter of credit is appropriate. Originality/value - It is expected that this paper can provide some assistance to banks, policy makers, and those engaged in international trade transactions when faced with the issue of use of economic sanctions as a defense to payments in commercial letters of credit.