The Circular Letter of Credit
The Letter of Credit is one of the oldest forms of transporting money, developed by European bankers just before and during the Renaissance. On the whole, it has been an extremely successful tool. Evidence of its success includes the paucity of statutes relating to letters of credit and how rarely disputes about them appear in the case law well into the mid-Twentieth Century. When the section of the newly crafted Uniform Commercial Code covering letters of credit was being reviewed for acceptance by the New York State Law Reform Commission in 1955, the introduction noted that “litigation involving letters of credit is relatively sparse”. A little later the text continues “Until now, the subject has remained almost entirely unregulated by statute.” The premise of the commercial LoC is that the issuing Bank, through a formal letter, indicates that Customer C has a line of credit with the Bank up to a specified amount. The standard form is used as a payment instrument in support of a sales transaction. The process involves the letter of credit naming a third party Beneficiary B, usually the seller of the goods subject to the transaction, and detailing the terms against which it can be drawn. The third party then presents the specified documents to the bank certifying that the underlying conditions have been met and claims the money. In the original medieval and renaissance forms, the Customer C tended to be the beneficiary himself. C would go abroad to transact his business and present the LoC to corresponding banks and obtain cash disbursal/s from those banks to the cumulative value of the initial instrument. The disbursing banks were then reimbursed by the issuing bank. Profits were made through the fees charged by the banks at both ends of the transfer. There are all sorts of variations on this process, but all involve this basic structure. As might be expected by its subject matter, the Uniform Commercial Code texts on letters of credit are focused on the commercial versions. In fact, Section Five’s original title was “Documentary Letters of Credit”, emphasizing how the practice being outlined was related to the documentation of the underlying transaction. These LoC's are used to support transactions of all types, especially between physically distant parties. However, through the 1970's the letter of credit also had what might be called a “consumer” version, closer in nature to its Renaissance form. This was the LoC that could be bought by a traveler to enable him to have money at different points in his trip and avoid the risk of carrying cash.
BackgroundIn the pre-ATM era, how was a traveler supposed to have cash on hand as he moved from country to country? Additionally, how was he able to keep his traveling funds protected from theft and robbery? Before the ATM was the credit card, and before the credit card was the travelers' check. Both are still in use today. But before any of these there was the Circular Letter of Credit, also known as the traveler's letter of credit. The letter of credit served two key functions in addition to the basic task of making money mobile: it provided some measure of protection against thieves and it helped protect against erosion of cash supply through repeated exchange transactions in moving from one currency jurisdiction to another. This website will focus on the now obsolete form of the LoC which was used as a means of financing a voyage through regions of varied currencies and uncertain safety, illustrating the forms and ancillary papers whose use by travelers flourished from roughly 1850 through 1950. Standard TextAlthough the exact wording of a letter of credit would vary from bank to bank, the core of the document would have a text somewhat like this:
The text could include additional clauses or side texts providing further stipulations such as:
As might be expected in a pre-electronic document, the form tended to be ornate, to reflect the prestige of the issuing bank, and graphically complex, to foil forgery. Often the forms were printed by the same companies that printed banknotes. They were usually printed on a large piece of high-grade paper folded over to make 4 pages. After being filled in and signed at the issuing bank, the customer would be given the LoC and a small leather wallet to hold the LoC and other documents that might accompany it, such as a list of corresponding banks if this were not already printed as part of the LoC itself. Corresponding banks were particularly important because they had overtly committed to honoring the issuing banks LoC's and had been sent copies of the authorized signatures of the bank officers that would be found on the LoC. What a Circular Letter of Credit Looked LikeHere are some examples of the fully developed Circular Letter of Credit as carried by the traveler: 19__, Carnegie Trust Company, New York: Specimen. 193_, Banco di Roma, Rome, unused: Page 1, Page 2, Page 3 1893, Baring Brothers/Kidder, Peabody, Boston, as used by George Hoar: Page 1, Page 2 1866, John Munroe & Co., Paris, as used by Neal Dow: Page 1, Page 2 Components of the DocumentThe elements of the standard traveler's letter of credit included:
The ledger listed each debit against the total amount of the letter of credit, serving both as a record and as a means to inform each new bank how much had already been drawn against the LoC in previous transactions. If a ledger entry was not made, the paying bank might not be reimbursed by the issuing bank if the absence of an entry resulted in a loss by the issuing bank. The Hoar LoC ledger shows advances made by banks in London, Birmingham, Paris, Berne, etc. as Senator Hoar made his way around Europe. It records advances of 891 pounds against a total value of the LoC of one thousand pounds. As a general rule, an exhausted LoC was to be kept by last payer bank or returned to the issuing bank. This means that in a world where every kind of old thing has become a collectible, used letters of credit are relatively rare. The text of letters of credit was often in French even though the issuing bank was not French. For example, the Hoar LoC, issued in Boston by Kidder, Peabody on behalf of the Baring Brothers Bank in London, is in French. This reflects the practice of using French as the international language of commerce and diplomacy through roughly World War Two. If the letter of credit was approaching exhaustion and the bearer still intended to stay abroad, it could be renewed. In May of 1873, Mrs. Mary W. James wrote to her son Henry "Uncle Robertson writes that the term of your letter of credit expires on June 1st -- that there are still between two and three hundred pounds due upon it, but the time must be renewed -- Father wrote him to extend the term another year, and add $2,000 to the amount -- this will be satisfactory to you?" Used forms illustrating renewed letters have not turned up. The 1921 American Express instruction booklet has details on renewing a letter of credit, although the process as described involves issuing a new form, which, if standard, may explain the lack of renewed forms. Letters of credit provided by smaller banks were often issued in the name of a larger banks. The smaller bank often lacked the widespread reputation and the network of corresponding banks needed to make the process work in its own name. Another example besides the Hoar LoC is the example from Bishop & Company in Hawaii which incorporates a reference to the Bank of California in San Francisco. It was accepted by corresponding banks on the Bank of California's reputation, not Bishop's. Page Three of the Banco di Roma LoC illustrates another means of indicating the maximum amount available through the letter. The corresponding banks are instructed to cut off the boxes showing any figures indicating a value higher than the current amount available through the LoC. Thus the officers of the corresponding bank were to both enter the amount given to the bearer in the ledger on pages 2 or 3 AND snip out the appropriate boxes at the bottom of page 3. Corresponding BanksWhile a given letter of credit might be honored by a distant bank simply due to the reputation of the issuing bank, a network of corresponding banks was developed by issuing banks to make certain that there would be at least one bank in each major city that would have agreed in advance to honor any of the issuing bank’s letters of credit. The issuing bank would supply corresponding banks with specimen copies of the LoC forms and examples of the signatures (Page 1, Page 2) of the bank officers authorized to sign the forms. This would allow verification of the authenticity of both the document and those signatures. In some cases the issuing bank’s “signature” was the name of the bank as written by an officer, not the bank officer’s personal signature. The LoC purchaser would be given a list of the corresponding banks either printed directly on the back page of the LoC or as a separate sheet. Banks would also print up drafts for the LoC collection process. These forms, similar to modern checks, left blank spaces in appropriate places that served to record the issuing bank's name and the number of the letter of credit involved. In the example from the Midland Bank Limited, there is space both for the bank expected to pay the draft and the issuing bank, if it were different. In this case they are the same. Identification of the HolderAs with all transactions with components that took place at a distance, correct identification of the participants was vital. An early example of the steps taken in relation to early letters of credit comes from a 1796 book The Seaman’s complete daily assistant...., page 48
As letters of credit became less personal and more a matter of filling out forms, this developed into the need for the holder to carry a “Letter of Indication” as well as the LoC itself. The key piece of information on a letter of indication was the bearer’s signature. This gave the corresponding bank officer an example to compare to the signature that the bearer executed in front of the officer. The letter often also had a signature of an officer of the issuing bank as an additional bulwark against forgery. The letter of indication was supposed to be kept separate from the LoC so only one or the other might be stolen or lost. Some later forms of the letter of credit also kept the purchaser's signature off the main LoC and confined it to the letter of indication. In that way a thief would not have a model signature from a stolen LoC to copy. Eventually this evolved into a simple signature card. As photography became more widespread, some signature cards were designed to hold a photo of the bearer as well. Costs and FeesA 1907 pamphlet describing the LoC's offered by Kountze Brothers in New York states that the cost of a letter of credit was "the posted rate for demand drafts on London plus a commission of one percent" with a minimum commission of five dollars. Thus to purchase a $500 LoC, the customer would pay $500 plus the demand draft fee, plus a commission of $5. A 1921 American Express booklet indicates the cost of a domestic letter of credit to be one half of one percent and one percent if drawn in a foreign currency. A bearer could also expect to pay some sort of small fee from the corresponding banks each time the Letter of Credit was drawn upon. If there was an unused balance at the end of the voyage or the term of the LoC, it was refunded to the purchaser upon surrender of the instrument. The letter of credit was not available to the poorer travelers or immigrants. Only a tiny proportion of the population could afford them. The minimum amount an Amex LoC would be sold for was $500 and the text reports a current (1921) average of $5000 per LoC. That $500 minimum for a letter of credit in 1921 converts to roughly $5000 today. Hoar's one thousand pounds sterling in 1892 was worth, incredible as it may seem, around $100,000 today. The Hawaiian LoC for $7000 converts to roughly $150,000. An Early ModelArchives in Europe contain texts that served the same function as letters of credit at least as far back as the Crusades. These forms are first found as adjuncts to royal fundraising and diplomatic activities. Other early uses were to support scholars traveling to distant universities and merchants on trading trips. Primitive LoC's were in fact simply letters carried by travelers and issued through families or business networks developed from extended families, combining a personal note of introduction with a guarantee to repay any money advanced to the bearer. Here is a simple example from a book of model letters and forms known as The Secretary’s Guide published in London in the early 1700's:
It can be assumed that this worked only if the person to whom it was addressed knew the signatory. As international travel became more necessary and popular, and less personal, a regularized way of brokering access to local cash developed, culminating in the standard Circular Letter of Credit. A relatively clear and detailed contemporary introduction to early use of Letters of Credit can be found in this PDF excerpt from Richard Hayes's The Negociator's Magazine: or, The Exchanges Anatomiz'd, pp 263 - 268, (1724). This is adapted with permission from the Thomson/Gale database “Eighteenth Century Collection Online" (ECCO) . Other explanations and examples of early model texts can be found in a number of similar works in ECCO, an image-based database of items published in the English speaking world in the 1700's. Vulnerabilities of the Letter of CreditLetters of credit could be stolen, forged, or simply lost. Keeping the letter of indication separate from the LoC was important to prevent forgery. Also, since LoC's were usually issued with a time limit, that date acted as a kind of stop-loss tool for stolen or misplaced LoC's. This postcard illustrates part of the response by a bank to a reported loss, informing corresponding banks of the problem. The card reports a loss in Dresden and is addressed to a bank in Frankfurt. Presumably all the corresponding banks in the area would have been informed. This letter from Lord Berwick to his London bankers, Morland and Company, in 1797 illustrates another problem during parlous times. As his ship was being taken, presumably by the French, Berwick threw all his papers overboard, including his letter of credit. On arrival in Amsterdam, Berwick was able to get Braunsberg and Company to advance him 200 pounds on his personal note drawn on Morland. A Letter of Credit FraudA rare appellate decision related to a circular letter of credit based fraud is Regina v Gabriel sans Garrett, (1853) Dears 232, reprinted in 169 E.R. 707 [Justis Online]. The factual summary below merges paragraphs of the original text with clarifying interpolations by a later judge and is from a US case which was citing it for non-LoC reasons (State v. Gibbs, 20 Ohio Dec., 1-25[1909]) [Lexis].
Garrett was charged in England with defrauding the English company because the Russian bank attempted to collect on the LoC in England. The conviction was quashed because his actions related to the Russian transaction. What the Russian bank did could not be held against Garrett. ConclusionOne of the ironies of progress is that the more things are made easy for the average person, the more the complexities of our ancestors' lives take on a romantic glow. The circular letter of credit is a clue to how travel used to be complicated and chancy. The transactions associated with using a letter of credit have a certain reassuring formality and stateliness to them. But the reality is that any holder of a LoC would probably have given his right arm for the speed and simplicity of an ATM card. Postscript: Collecting Letters of CreditLetters of credit, like ornate stock shares, are now "collectibles" within the field known as Scripophily. They can be found on Internet sites or in more traditional auctions of historical memorabilia, commercial documents, and stamps. The prices vary enormously, from roughly twenty dollars through a few hundred dollars. The reasons for the price variations do not always seem obvious. However, LoC's are relatively rare. Because they were to be returned to the issuing bank by the last paying bank, they did not normally end up among the accumulated personal papers of the traveler. The Hoar example was not exhausted and perhaps ended up in family papers or the papers of a staff member. Most of those offered for sale are specimen copies that were never used.
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