Illegality in the Underlying Transaction: A Defence to Dishonouring Letters of Credit?

Abstract

This paper raises doubts over the seemingly prevailing view that illegality in the underlying contract for international trade should be accepted as an exception to the autonomy principle of documentary letters of credit. Contrary to the seemingly prevailing view, this paper argues that there are logical flaws in the “illegality exception” arguments. It suggests that where commercial documentary letters of credit for international trade are involved, the “illegality exception” would much less likely than expected to be accepted, especially in most common law jurisdictions. It also submits that the public policy concerns over letter of credit being used to facilitate illegal transactions could be better addressed by public law such as specific statutory provisions rather than by an ill-founded and loosely formulated “illegality in the underlying contract defence” in private law.