Red clause letters of credit originated as a means of providing sellers financing for purchases or production of goods. They allowed sellers to receive advances from the issuing or confirming bank before shipment using the letter of credit as collateral. While once common, red clause credits are now rarely used, being largely replaced by other forms of financing. Recent cases discuss liability and remedies under these historical letters of credit, but they remain mostly a thing of the past, confined now to only occasional or niche uses.

1. CERTAINTY IN
CONTRACTUAL
OBLIGATIONS:
Red Clause Letters of Credit

2. “RED INK”
(AND “GREEN INK”)
CLAUSES AS
PRESENTED
THROUGH A
“BLACK-LETTER”
PERSPECTIVE?
Roberto Hernandez

3. RELEVANCE?
“Red ink clause credits are now largely historic…”
“A green ink clause credit is a variation of the ‘red ink’ clause… These credits are
now seldom if ever used.”
- Weaver at [15.1650].
“This type of credit [red ink clause] developed in Australasia especially in the wool
and fishing export industries… These now appear to be used only infrequently.”
- Burnett and Bath at 230.
“On the evidence relating to ‘Red Clause’ letter of credit, I am satisfied that they
are now rare, especially in the log trade.”
- Course Materials at 278.
“The red clause is today dying out.”
- Gutteridge and Megrah at 13.
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4. TERMINOLOGY
General Specific
UK US
Red Clause Anticipatory Letter of “Packing” Credit
Credit
Red Clause Credit Supplementary Clause “Export Packing”
Credit
Red Clause Letter of
Credit
“Red Ink” Clause
Credit
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5. HISTORICAL AND COMMERCIAL
CONTEXT
- Originally written in red ink to draw attention to
the credit’s unique nature
- Developed in Australasia
- Largely confined to the following trade areas:
- Fur
- Wool
- Fishing
- Timber
- Coffee
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6. “RED INK” CLAUSES
Characterization:
Irrevocable and anticipatory credit
- Gutteridge and Megrah, The Law of Bankers’ Commercial Credits (7th,
1984) at 12-13.
Function:
Red clause in a letter of credit that permits the seller to receive temporary
advances from issuing/confirming bank to enable it to make purchases
and/or ship goods described in the credit. The advances are then repaid with
interest out of proceeds of the seller’s drafts and ultimately drawn under the
credit.
- Course Materials at 277.
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7. Buyer 11 Examines documents and
delivers them to Buyer and
2 Requests his bank to issue receives payment; Buyer
an anticipatory credit in favor uses documents to obtain
of the seller goods 10 Checks documents
against credit and
Bank A disposes of them as
instructed by the credit;
3 Issues credit and
1 Contract of claim reimbursement
advises it to the seller
Sale/Advance through an advising bank Negotiating Reimbursing
Arrangement 4 Asks for guarantee Bank Bank
Bank B
9 Uses proceeds from
5 Authenticates the advice and credit to repay red clause
advices the seller the terms and (including interest)
conditions of the credit; makes
8 Prepares documents and
advance (usually requires
makes drawing from the
some form of security)
credit
Seller
6 Uses advance to fund 7 Ships goods
purchase or production of
goods
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8. LIABILITY
- If advance is not repaid by the seller, the issuing
bank becomes liable for the amount (usually also
paying interest to the confirming bank).
- The issuing bank would then need to claim from
the buyer.
-Course Materials at 274.
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9. “RED INK” CLAUSES
- E.g.
“Advances are available under this credit against the
beneficiaries’ simple receipt countersigned by Jonathan
Franklin or Hugh Gathorne-Hardy presented to ourselves
[- that of course is Barclays Bank.] Reimbursements will
be made by air mail to a bank of your choice as soon as the
receipt is received by us and in order. Each advance
clearly states which lots it refers to, the proceeds of each
negotiation will be applied in reduction [ - then I think
should be inserted the word ‘of’ - ] the relevant advance on
that lot, recourse of advance to be to beneficiary in the case
that goods have not been shipped by expiry of the credit.”
- Tukan Timber Ltd. v. Barclays Bank Plc. [1987] 1 Lloyd’s
Rep 171 at 173.
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10. Source: Gutteridge and Megrah at 307 (Appendix E - Form 8)
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11. NATURE OF RISK
- Red clause credits are a form of unsecured loan.
- Seller = Safe
- Buyer = High Risk
-Thus, the Buyer must have extreme trust in the
Seller.
- And/or attempt to minimize risk:
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12. CONSIDERATIONS OF A PRUDENT PERSON
1. Specifications and agreement on the maximum amount to be advanced
2. Agreement on date and conditions of pre-shipment advances permitted
3. Agreement on documents – and number of copies (e.g. commercial invoice,
tally sheet, certificate of origin)
4. Opt for additional safeguard requirements before corresponding draw
downs permitted (e.g. agreed independent third party’s certification that
goods have been assembled even before shipment)
5. Buyer should opt for initial substantial quantity of goods to be assembled
6. Negotiate interest payable on early advances, or a discount on a purchase
price
7. Provide for the possibility of supplier default, either by:
a. Specifying an interest rate in the event of default
b. Declaration of trust in the buyer’s favor, stating that any advances are
for the purpose of the underlying contract to give the buyer priority in a
bankruptcy.
8. Negotiate when ownership and risk passes and subsequently who bears the
cost of insurance.
-Course Materials at 277.
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13. “GREEN INK” CLAUSES
- Function:
I. Pre-shipment advances are made in the same
way as a red ink clause
II. BUT goods purchased are stored in the bank’s
name
III. Bank is then authorized to release goods to the
beneficiary to enable the beneficiary to ship them.
-Weaver at [15.1650].
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14. CASE LAW
South African Reserve Bank v. Samuel & Co., Ltd. (1931) 40 Ll. L. Rep. 291
HELD: Bank authorized to allow anticipatory drawings, advances to be paid out of proceeds of documentary drafts when shipping
documents available, the red clause drawings to be covered by security put up by drawer.
French American Banking Corporation v. Isbrandtsen 126 N.Y.S. 2d 853 (1953)
HELD: Neither the plaintiff nor its corresponding bank owed a duty under the red clause letter of credit other than to obtain an
undertaking within the terms of the credit with respect to the supporting shipping or title documents.
Abe Schrader Corp. v. Legend Apparel Mfg. Co. 581 N.Y.S. 2d 319 (1992)
HELD: Issuing bank was not liable to corresponding bank for advances made to defendant pursuant to the red clause in the letter of
credit since the corresponding bank failed to offer evidentiary proof that it has sought reimbursement in accordance with the
terms of the letter of credit. Further, since there was no basis to conclude that corresponding bank has made a presentation of
documents for payment, the issuing bank was not required under Article 16 of the Uniform Customs and Practice for Commercial
Credits to give the corresponding bank notice of its refusal of the documents or to return the documents.
Tokyo Kogyo Shokai v. U.S. National Bank of Oregon 126 F. 3d 1135 (9th Cir. 1997)
HELD: Letter of credit applicant could not subrogate to position of issuing bank and sue confirming bank nominated to make
advances under the red clause for fraud, negligence and violation of the Uniform Commercial Code (US).
Leonard A. Feinberg, Inc. v. Central Asia Credit Corp. 974 F. Supp. 822 (E.D. Pa. 1997)
HELD: Article 5 of the Uniform Commercial Code (UCC) would not govern letter of credit dispute concerning liability of nominating
bank, which was authorized by issuing bank to advance funds to letter of credit beneficiary but which allegedly misapplied funds
to pay down beneficiary’s loans instead of advancing funds in conformity with letter of credit’s red clause, where Art 5. of UCC
did not address nominating banks at all; thus, customer would instead be allowed to pursue common law remedies against
nominating bank.
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15. RELEVANCE REVISITED
- Recent case law
- Commentary stating popularity of red clause
-E.g. Grassi and Laryea
- Minimal impact of “paperless trade” and newer forms of
electronic payments
-According to Laryea, documentary credits will only become
irrelevant:
a. Where the needs served by credits are no longer present;
b. Where there is an alternative way for meeting those needs
(i.e. an alternative method of payment that would ensure
security, liquidity, and proximity)
c. Where credits are electronically inoperable.
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16. REFERENCES
Burnett, Robin and Vivienne Bath. Law of International Business in Australasia
(2009).
Grassi, Paolo S. ‘Letter of Credit Transactions: The Banks’ Position in
Determining Documentary Compliance: A Comparative Evaluation Under U.S.,
Swiss and German Law.’ (1995) 7 Pace International Law Review 81.
Gutteridge, H.C. and Maurice Megrah. The Law of Bankers’ Commercial Credits
(7th ed, 1984).
Herries, M.S. ‘Overseas Commercial Credits.’ (1925) 36 Journal of the Institute
of Bankers 79.
Laryea, Emmanuel T. ‘Payment for Paperless Trade: Are There Viable Alternatives
to the Documentary Credit?’ (2001) 33 Law and Policy in International
Business 3.
Weaver, G.A. The Law Relating to Banker and Customer in Australia (3rd ed,
2003).
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