Document Type
Article
Publication Title
Michigan Law Review
Abstract
This paper comments on Ronald Mann's article "The Role of Letters of Credit Transactions." In that article, Mann contends that, contrary to traditional understandings, the function of the letter of credit is to solve informational asymmetries by allowing an issuer with superior information to verify a buyer's legitimacy to the distant seller or to the buyer's government. He contends that traditional understandings of letters of credit are inconsistent with practice, particularly the systematic honor of drafts presented with discrepant documents. In this paper, I raise various issues that contest Mann's claim. First, there exist explanations for the honor of discrepant documents that are consistent with traditional understandings of documentary transactions. For instance, presentment of discrepant documents does not indicate defects in the underlying transaction, and banks have incentives to honor drafts unless they are aware of such defects. Second, Mann's suggestion that issuers signal the creditworthiness of their customers has little explanatory power, since, once the credit is issued, the beneficiary looks to the issuer for payment and thus is indifferent as to the customer's reliability. Third, any signal concerning the customer's creditworthiness that emerges from issuance of the credit is relatively opaque and could be replaced at lower cost by more precise indicators of reliability. Finally, Mann's suggestion that issuers of credits solve an informational problem among diffuse and geographically distant commercial parties ignores the likelihood that the same collective action problem that precludes communication about buyers also precludes communication about the reliability of different banks. The paper concludes with remarks about the need for careful rather than casual empiricism and the utility of relying on bank officials alone to determine the proper role of letters of credit.
First Page
2537
DOI
https://doi.org/10.2307/1290353
Volume
98
Publication Date
2000
Recommended Citation
Gillette, Clayton P., "Letters of Credit as Signals: Comments on Ronald Mann’s ‘The Role of Letters of Credit in Payment Transactions'" (2000). Faculty Articles. 493.
https://gretchen.law.nyu.edu/fac-articles/493
