The manager of the international department of the McAllen Bank learns on the way to work that the ship on which a local exporter shipped some goods has sunk

Problem: The manager of the international department of the McAllen Bank learns on the way to work that the ship on which a local exporter shipped some goods has sunk. The manager has received all the documents required in the letter of credit and is ready to pay the exporter for the shipment. In view of the news about the ship, the manager now knows that the foreign customer will never receive the goods. Should the manager pay the exporter, or should he withhold payment and notify the overseas customer?

Solution:
The short answer is that the banker should do exactly what the terms of the letter of credit specify; in fact, the L/Cs are normally irrevocable and unchangeable.

If, for example, the letter of credit dictates that payment shall be paid upon shipment of the goods, then the banker should comply. However, if the L/C says that payment will not be made until the goods are received, then he should not comply. There also may be conditions in the L/C as to how to proceed in unusual situations. Regardless, if the terms of the L/C are met, the banker is legally obligated to complete the transaction.

For sake of this problem, let us assume that the L/C states payment can be made upon shipment of the goods. The relationship of the banker to the transaction is closer to one of agency rather than a party to the transaction, and he is bound by the terms of the agreement. But in the practical world of commerce, the banker would undoubtedly stop and desist from any action at all until he is advised how to proceed.

Of course, the banker would notify both parties with his information, and would ask both for instruction on how to proceed. It could be that the L/C (and the transaction) will be cancelled and an insurance claim will be filed.

http://en.wikipedia.org/wiki/Letters_of_credit