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Two experts consider UCP article 15 and "reasonable time"


Extracted from DCInsight Vol. 18 No.4 October - December 2012


Wanted: a more positive article 15


by Rupnarayan Bose


The expressions "reasonable time" and "without delay", because of their nonspecific nature, came under intense scrutiny during the drafting of UCP 600. "Without delay" survived, but the appearance of the expression "reasonable time" in sub-article 13(b) of UCP 500 was to be its last. The latter was removed completely from UCP 600. Five years on, few seem to feel its absence.


"Without delay" conveys a greater sense of urgency than "reasonable time". "Reasonable time" stretches the permitted time to an outer limit that could perhaps be justified under a given circumstance. Yet, both of the expressions are subjective in nature; neither indicates any definitive time frame nor a globally acceptable standard. It's debatable whether any period could, in all fairness, be set as a "reasonable time". Hence, it could not be part of any internationally applicable rules. If considered from a technical or legal point of view, a definite number of days was desirable. But even in its absence, most people preferred clear definitions and guidelines, blackand- white solutions over stipulations that were indefinite or vague in nature.


"Without delay"


The term "without delay" posed similar problems. A few members of the UCP 600 Drafting Group felt that the term should be disregarded, as were similar terms in the UCP such as "immediately" and "as soon as possible". This was because, like "reasonable time", "without delay" did not specify a definite period. Finally, it was decided to live with the expression, with the expectation that banks would act in accordance with the intent with which the words were used, i.e., expeditiously. In the final version of UCP 600, the expression "without delay" appears in six places.


The demand for setting a fixed number of days had its opponents. They insisted that the reason for having retained "reasonable time" in the UCP was that not every situation or circumstance could be envisaged in advance, rigidly defined or put in a straightjacket. The variety of credits was considered to be too complex. The inclusion of these expressions was said to convey a sense of responsibility and accountability. One view was that if the concept of "reasonable time" were removed, a bank might not take the initiative to examine the documents presented and to pay well before the maximum period allowed under a credit. The expression "reasonable time", they claimed, saved bankers from having to justify to either party why the applicant had to part with the funds earlier than the maximum period allowed, or why it took more than a day or two to honour the documents presented.


Clarity


Thus, the UCP 500 expression "shall each have a reasonable time, not to exceed seven banking days" allowed some leeway, with a built-in safeguard by way of a cap regarding the outer limit for the examination of documents. From the revised UCP 600 expression "shall each have a maximum of five banking days" (emphasis added), it could appear that ICC was not reducing the time from seven to five banking days; instead, it might be claimed that the available time was only being increased from a shorter time frame (guided by the circumstances of each case and practical considerations) to five days under the new UCP.


Even so, the majority of the Banking Commission members desired clarity. When the issue came up for a vote at the June 2005 Dublin Meeting of the Commission, all except one country voted for the removal of all references to the words "reasonable time". This made life easier for the Drafting Group, though the late Ole Malmqvist wrote: "For the Drafting Group, that was a nice clear decision, but I wonder if that change will lead to a general delay in payments to beneficiaries. If it does, we trade finance bankers will regret that we deleted it, and in a few years - fewer than if we retain the 'reasonable time' concept - we will have plenty of time to wonder why we did it."


Further steps


In addition to doing away with the undefinable concept of "reasonable time" in favour of a fixed number of days, the Drafting Group went a step further. It wrote into the rules a new article, article 15, titled "Complying presentation". This article states in clear terms what, until then, had been confined largely to considerations of "international standard banking practice". The new article now sought to delineate the responsibilities of a nominated bank, a confirming bank and an issuing bank on receipt of a complying presentation. Whether article 15, as it stands today, helps to add any value, any new dimension or rule to the existing practice, is debatable.


Any modification to the rules which helps to remove grey areas is always welcome. From that standpoint, although "without delay" remains, deletion of "reasonable time" was as welcome as the addition of article 15 to the rule book. The insertion of article 15 in the UCP is an instance of not relying wholly on international standard banking practice (yet another vague expression), but making the rules more specific.


A "black hole"?


What puzzles this writer is the reason why the Drafting Group did not take the provisions of article 15 to their logical conclusion. While they went to considerable lengths to eliminate and replace vague, non-specific phrases, they appear to have left a procedural "black hole" in article 15.


Sub-article 15 (a) states: "When an issuing bank determines that a presentation is complying, it must honour." Quite so! But the question is "When, within how many days?" What's the point of creating a so-called rule to tell the issuing bank that it must honour (nothing new there; the issuing bank is already bound by article 7 to do so), but stop short of stipulating a reasonable time for the same?


A similar question arises with regard to sub-article 15 (b). It states: "When a confirming bank determines that a presentation is complying, it must honour or negotiate and forward the documents to the issuing bank." Apart from the matter of forwarding documents, this sub-article simply repeats a section of sub-article 8 (a). The confirming bank is under no obligation or compulsion to negotiate within a "reasonable time" (similar to the issuing bank), or to forward the documents "without delay" to the issuing bank.


Sub-article 15 (c), the last in the trilogy, is stranger still. It states: "When a nominated bank determines that a presentation is complying and honours or negotiates, it must forward the documents to the confirming bank or issuing bank." Nothing unique here. It's acknowledged that a nominated bank is under no obligation to negotiate even if a presentation is complying. But what about its obligation to the presenter to either negotiate or to return the documents - all within a reasonable time, without delay? Is this too much to ask?


A remedy


Sub-article 7 (c) begins with the sentence: "An issuing bank undertakes to reimburse a nominated bank that has honoured or negotiated a complying presentation and forwarded the documents to the issuing bank." The absence of any mention of "reasonable time" or "without delay" here is not only perfectly acceptable and logical, but also eminently desirable. However, the issuing bank could face difficulty in refusing to honour or pay against reimbursement claims received after considerable delay (e.g., documents negotiated subsequent to a complying presentation, but received by the issuing bank, say, one or two years after the expiry or cancellation of a credit). In case of such refusals, the issuing bank has no protection today under the UCP. Under sub-article 7 (b), the issuing bank is "irrevocably bound" by its undertaking to honour. This undertaking is open-ended; it provides for a last date only for the presentation of documents (article 6), but none whatsoever for its expiry. Tweaking article 15 provides an opportunity to remedy this situation.


In its present form, article 15 hardly states anything that has not been stated elsewhere in the UCP. What it fails to do is spell out the obligations of the banks as conclusively as possible. For the reasons stated here, article 15 should be taken to its logical conclusion by adding either "reasonable time" or "without delay" to each of the three sub-articles. This would add a positive, decisive thrust to the rules and underscore the reason why "reasonable time" in the UCP was replaced in the first place with a definite period of time.


Rupnarayan Bose is former managing director of Fina Bank Ltd., Nairobi and TransAfrica Bank, Kampala. His website is http://www.rnbose.net, and his e-mail is [email protected] 

"The use of 'when' created an elegant solution"

by Dan Taylor

As a member of the Drafting Groups for the revision of UCP 400 and 500, I read with interest Rupnarayan Bose's article titled "Wanted: A more positive article 15".

The usage of the term "reasonable time" and the issues associated with it in the UCP are well-documented in numerous opinions of the Banking Commission and articles and, with the introduction of UCP 600, the expression is no longer a part of the rules. The use of the term "without delay" dates to the original 1933 (actually the 1929 draft) UCP and has been used in various ways in every UCP since. Based on its usage and understanding in relation to documentary credit processing, it has become a term of art for letter of credit practitioners and seems to be well understood to account for the variations in processing procedures.

As to the issues with the use of "When" in article 15, I would draw specific attention to the explanation in the Commentary on UCP 600 (Article-by-Article Analysis by the UCP 600 Drafting Group). I believe that these words clearly articulate the intentions of the Drafting Group.

"The essential word in each of the subarticles is 'when'. The introduction of this concept was necessary as a result of the removal from the UCP of the term 'reasonable time' in relation to examination of documents and the provision in article 14 of a maximum of five banking days following the day of presentation to determine compliance. The word 'when' does not mean immediately, but indicates that the process of honour or negotiation must begin. During the normal work flow for documentary credits, it can often take some time after the actual determination that the documents comply to conclude the processing of the transaction. This could range from an hour to a day, depending on the work flow and the time of day that the determination is made. Banks regularly have cut-off times for the processing of work late in the day, which can mean that an actual payment might not be effected until the following day."

The use of "when" created an elegant solution to connote the specific time when action should be taken and provides for the variations in processing.

Dan Taylor is Vice Chair of the ICC Banking Commission and Executive Director, TSS Global Market Infrastructures at J.P. Morgan in New York. He was a member of the UCP 600 Drafting Group. His e-mail is [email protected] jpmorgan.com

DCInsight Vol. 18 No.4 October - December 2012


by Roberto Bergami


ICC has played a crucial role in international trade facilitation over the past century. Some of the most important initiatives in this area include the Uniform Customs and Practice for Documentary Credits (UCP) and the Incoterms® rules. The codification of these processes has continued in a regime of regular updates, to foster a consistent trading environment with predictable outcomes in specific business processes, no matter where they happen on planet Earth. This can be observed through the universal adoption of the current UCP 600, the release and uptake of the Incoterms® 2010 and the current revision of the ISBP that is occurring at the time of writing this article.


It must be remembered that ICC, despite the important and crucial a role it plays in international trade, is neither a government organization nor an international lawmaking body. This means that any rules ICC promulgates are subject to the provisions of the laws of individual nations. This also means that UCP 600 and Incoterms® 2010 rules, the focus of this article, must be voluntarily incorporated in relevant contracts, or else they will not apply.


In fact, the UCP have enjoyed little incorporation into national legal systems, with the majority of countries leaving it up to banks and traders to strike commercial arrangements (contracts) for letter of credit transactions and the incorporation of Incoterms® 2010 into contracts. Not unexpectedly, the codification of any process is subject to different interpretation by individuals, and this is where the problems arise, as discussed below. It should be noted that this article is limited to international trade transactions and, therefore, does not deal with domestic transactions.


Incoterms®: the importance


It is commonly accepted that bankers are a vital link in trade finance, and a number of solutions have evolved over the centuries to keep the international wheels of business turning. The L/C remains probably the most important international method of payment, especially in the context of high-risk/ high-value transactions, and exporters, generally speaking, perceive the L/C to be safest form of payment.


Problems arise in the context of L/C transactions when Incoterms® are used, as it appears there is misalignment between what bankers demand and what good Incoterms® practices suggest. Incoterms® are extremely important from a number of perspectives, including:


• costing of goods for export and import;


• a means of delineating the responsibilities of traders, on a mutually exclusive basis, on matters related to delivery of goods, such as customs clearance, freight and insurance; and


• a risk management tool, particularly as this relates to goods in transit.


Improper use


However, when Incoterms® are improperly used, many of their benefits are lost, especially through the incorrect application of these rules to the different modes of transport, an important consideration in the new Incoterms® 2010 rules, effective from 1 January 2011.


In order to explore the extent of these tensions a random survey of L/C application forms available on the Internet was conducted in the first quarter of 2012. The enquiry concentrated on the Incoterms® 2010 options that each bank offered on its L/C application.


A summary of the findings are shown in Table 1. For the purposes of anonymity, banks are not named in this article, but the countries from which they operate are identified. The total number of online application forms found in the survey was 23, but four of these were excluded from Table 1. Three forms (2 x Australia and 1 x Malaysia) correctly showed all eleven Incoterms® 2010 options available to applicants to choose from. The fourth form (Finland) was excluded as it showed no Incoterms® 2010 at all on the application form. It was interesting to note that in the accompanying completion instructions, these referred to Incoterms® 2000, not Incoterms® 2010.


It is commonly accepted that maritime transport is by far most commonly used in international commercial transactions, and of this the majority is carried in containers. The inappropriate use of traditional maritime terms such as FOB, CFR and CIF has been highlighted for about three decades now, but it seems old habits die hard. It is known that traders inappropriately use these, but bankers are seemingly no better at correctly applying Incoterms® to the relevant mode of transport. This assertion is based on the fact that, as can be observed from Table 1, all L/C applications, except one in Germany, feature these three Incoterms®. In percentage choice, these three Incoterms® account for 55% of options, and consequently it is not difficult to see the misalignment between banking practices and the correct application of Incoterms® 2010 to modes of transport.


The precise reasons why bankers continue to use old and incorrect Incoterms® are not known. The explanations could be many, and no doubt a degree of "defensive" reasons could be cited by the banking industry, but these cannot be allowed to excuse or condone the current status.


Paradox


It seems that a paradox in practices exists in L/C banking practices. On the one hand, banks claim they vigorously comply with the ICC-issued UCP 600 and follow it to the letter, relying on the assistance of the ISBP for clarification on the interpretation of these rules. On the other, the Incoterms®, also issued by ICC, appear to be ignored, perhaps not understood at all or deemed to be not of concern to the banker. However, it should be of concern to all parties dealing in L/C transactions, as the choice of Incoterms® influences the type of document required to be presented.


The problem can best be illustrated with an example using the data from Table 1. The German bank only has FOB and CIF as the Incoterms® option. What transport document would they demand if the consignment was transported by air? An air waybill hardly fits with either of these terms, yet this is what is routinely issued by carriers.


Consequences of misuse


One of the problems with the misuse of Incoterms® is that bankers, by playing a central role in international trade finance facilitation, open L/Cs with incorrect terms, and they may unwittingly also influence traders to cave in to banks' pressure and structure their contracts accordingly, just to keep the banker happy and get the L/C issued so business can take place. The bank has little interest in the transit risks that traders are exposed to and, in one sense, the UCP 600 support this through article 34 of UCP 600 that states inter alia that the banker has no responsibility for the existence of the goods because, pursuant to article 5, banks only deal with documents and, in any case, the wellestablished autonomy (or independence) principle separates the L/C from the contract. I would argue that for traders the L/C is only one part of the overall business dealing - an important part, I'd be the first to admit, but only one part nevertheless.


What would happen if cargo was damaged and the incorrect Incoterms® chosen? It would just make the issue of working out who carried the risk in transit more difficult, especially when containers are involved, as container movements are invariably part of multimodal carriage. From a risk management perspective, it is more preferable to have certainty in transactions, and this can be easily achieved by the correct usage of Incoterms® 2010.


I hope this article will be interpreted by the banking industry as constructive criticism, and that it can help result in a review of L/C application forms to reflect the current Incoterms® 2010 and to show all of them on their forms.


This reminds me of a situation when, just prior to the introduction of Incoterms® 2010, I was asked to address a meeting of senior managers of a bank about supply chain finance. Unbeknownst to me, this was a national teleconference. During the discussion, I made a reference to the new terms (Incoterms® 2010) soon to become reality and made a passionate plea for their adoption. A banker, whom I had known for over thirty years, claimed it would be difficult to change because "the rest of the world is not doing it." My response to that was that "a revolution starts with the first sword."


Some banks have taken up their swords and made changes to their L/C applications. I trust that others will follow, as ultimately convergence on the correct application and usage of Incoterms® 2010 will benefit traders and bankers alike.


Perhaps it may be timely for the ICC to take note of these misalignments and issue a position statement to encourage the correct usage of Incoterms® 2010 by banks. They should as, after all, both UCP 600 and Incoterms® 2010 are ICCsponsored rules. lDCInsight Vol. 18 No.4 October - December 2012


Dr Roberto Bergami is Senior Lecturer, Practice of International Trade, School of International Business, Victoria University, Melbourne, Australia and Visiting Professor, Department of Tourism and Trade, Faculty of Economics, University of South Bohemia, Ceske Budejovice, Czech Republic. His e-mail is Roberto. [email protected] 

GUARANTEES - URDG 758: the balance sheet after two years

DCInsight Vol. 18 No.4 October - December 2012

by Georges Affaki

July 1st of this year marked the second anniversary of ICC's revised rules on demand guarantees, URDG 758, the first revision of the rules for 18 years. The response to the revised rules has far exceeded expectations. The URDG 758 were an instant success from the time they came into effect in July 2010. Almost immediately - and in at least one case, even before 1 July 2010 - demand guarantees and counter-guarantees started being issued worldwide subject to the new URDG 758. The transition provision in article 1(d) greatly facilitated the move. The percentage of guarantees subject to URDG 758 compared to those subject to URDG 458, or to no rules at all, has never stopped increasing since. Note the following developments:

• On 5 July 2011, the General meeting of the United Nations Commission on International Trade Law endorsed URDG 758.

• On 14 March 2012, the International Federation of Consulting Engineers upgraded the model guarantee forms used in connection with their model construction contracts to include the new URDG 758.

• The World Bank followed suit in July 2012. Other multilateral development banks are in advanced discussion with ICC to upgrade likewise their model guarantee forms from the current reference to URDG 458 to URDG 758.

• Bank regulators, including Bank Markazi of Iran, recommended their use by national banks. Lawmakers, including the Organisation for the Harmonisation of Business Law in Africa (OHADA), approved URDG 758 and used them as model for national statutes now in force in 16 countries.

• In Western Europe, guarantees and counter-guarantees governed by URDG 758 now account for 20 to 70% of the aggregate guarantee volume. The leading French, Italian and Spanish banks and savings and loan institutions are reported to offer URDG guarantees and counter-guarantees by default, i.e., systematic offering subject to their customers requesting an opt-out where mandatory guarantee forms are imposed by public beneficiaries. A number of the UK banks have also adopted URDG 758 as their default position.

• In the Middle East, reports from Turkey, Egypt and Jordan show an increase of 35 to 50% in the use of URDG 758.

• Bank of China reported that the Supreme People's Court of the PRC is examining the possibility to update its interpretative rulings on independent guarantees and considering the URDG as a restatement of customs and practice in international guarantees.

• URDG 758 are now available in 21 languages officially approved by ICC: Portuguese, Mandarin, Croatian, Czech, Finnish, French, German, Hungarian, Italian, Japanese, Arabic, Polish, Russian, Serbian, Slovanian, Spanish, Swedish, Turkish, Ukrainian, Bulgarian, and traditional Chinese.

Comprehensive

The URDG 758 do not merely update URDG 458; they are the result of an ambitious process that seeks to bring a new set of rules for demand guarantees that are clearer, more precise and more comprehensive. By offering a muchneeded clarification of the presentation and examination process and excluding imprecise standards, URDG 758 foster certainty and predictability. Some examples of provisions in the revision include:

• strict time durations for the examination of a demand, the extension of the validity period in the case of force majeure, and the suspension of the guarantee in the case of an extend or pay demand;

• the inclusion of important practices that had been left out of URDG 458, including the advice of guarantees, effectiveness of amendments, standards for examination of presentations, partial, multiple and incomplete demands, linkage of documents and transfer of guarantees;

• a number of innovations, such as the new rule that proposes a substitution of currencies when payment in the currency specified in the guarantee becomes impossible and the new termination mechanism for guarantees that state neither an expiry date nor an expiry event.

In June 2011, as a companion to the new rules and their embedded model forms, ICC published The Guide to ICC Uniform Rules for Demand Guarantees, ICC Publication 702, now in its second print run. This publication gives practitioners all the tools they need to apply URDG 758 in practice.

Queries on URDG 758

In the two years of use of URDG 758, the ICC Task Force on Guarantees received a number of queries regarding the proper interpretation of certain URDG 758 provisions. The majority of those queries were submitted before the release of the Guide to ICC Uniform Rules for Demand Guarantees and found an answer in the Guide. Other queries were considered by the Task Force as educational in nature or involving an ongoing dispute. Under the terms of reference of the ICC Banking Commission, no such queries can be processed as official opinions of the Commission. Following are excerpts of those queries, given their educational value:

Q. A guarantee stipulates that it expires on a specific calendar date but that notwithstanding the expiry date, the beneficiary may present documents to the guarantor until 30 days after the expiry date. Is it complying with URDG 758?

A. Article 14 provides that a presentation shall be made to the guarantor on or before expiry. After expiry, the guarantor is automatically released of its obligations under the guarantee and no longer has authority to receive, examine or act upon a presentation made after expiry. The guarantee referred to in the query is in conflict with URDG 758 and should not be made subject to the rules.

Q. A beneficiary is insisting on introducing into the guarantee a political risk clause covering the risk of currency control. Is there a need for such a clause where the URDG apply to the guarantee?

A. The independent nature of the guarantee, explicitly acknowledged in article 5, bars the guarantor from asserting a currency control regulation in the country of the applicant to escape its payment undertaking. A political risk clause adds little value in such a case. If the currency control is imposed in the country of the guarantor and results in the prohibition of payment in the currency of the guarantee being a foreign currency, article 21 requires the guarantor to pay in the currency of the place for payment.

Admittedly, if the place of payment is in the country that has imposed the currency control, the beneficiary would have no choice but to accept payment in the local currency. This is the case with or without the URDG.

Q. A guarantee is issued without any indication of an expiry date but stipulates one of the following clauses: "This guarantee will expiry upon Final Acceptance", "This guarantee is valid until completion of the contract" or "This guarantee is valid until released by the beneficiary". Does the three-year termination date in article 25 (c) apply?

A. All three clauses stated in the query are nondocumentary conditions, since they do not specify any document to indicate compliance with these conditions. Accordingly, article 7 requires that they should be disregarded except for the purpose of determining whether data that may appear in a document specified in and presented under the guarantee does not conflict with data in the guarantee.

Q. A counter-guarantee is issued through SWIFT MT760. Field 40C (applicable rules) indicates URDG but field 77C (details of the guarantee) indicates: "Our counterguarantee and your guarantee will be governed by Ruritanian law and place of jurisdiction Rurville." Is there a conflict with URDG articles 34 and 35?

A. Where the counter-guarantor has chosen the applicable law to both the counter-guarantee and the guarantee and has explicitly so indicated in the relevant field in the SWIFT message (40), the counter-guarantor's choice will prevail over the default rules in the URDG, i.e., articles 34 and 35. The counter-guarantor need not repeat its choice of law in the open message field 70c.

Q. Is a guarantor entitled to directly pay an extend or pay demand even without the consent of the instructing party?

A. Article 23 (a) provides the guarantor with the choice to extend or to pay upon its receipt of a complying extend or pay demand. If the guarantor has decided to suspend payment, it has to wait for the end of the suspension period that the guarantor has chosen in accordance with article 23 before the guarantor decides to extend or to pay. If the instructing party refuses the extension requested by the beneficiary, the guarantor remains free to extend the guarantee nonetheless but risks losing any right to be reimbursed by the instructing party for acting in breach of its mandate (unless it is authorized to do so in the application).

The future

Guarantee Task Force members are often asked whether the ICC Banking Commission will compile and release in the form of a booklet the International Standard Demand Guarantee Practice referred to in URDG 758 article 2. There is a consensus that any such publication would be premature at this stage. It took ICC ten years between the drafting of the then-novel concept of international standard banking practice in UCP 500 and releasing the first compilation of ISBP (ICC Publication 645, now updated to ICC Publication 681).

That said, the Task Force is regularly compiling practices fed back to its members through the numerous workshops organized around the world on URDG 758, the queries submitted to the ICC Banking Commission and its own members' experience as demand guarantee experts. In due course, those practices would likely evolve into a compilation of ISDGP. In the meantime, readers should remember that the International Standard Demand Guarantee Practice - like the International Standard Banking Practice for UCP - are a method to identify on a case basis the proper international practice to answer a question not covered in the terms of the guarantee or the URDG. Even when codified and released, the International Standard Demand Guarantee Practice will not - and should never be - an exhaustive recital of all guarantee practice, for that would jeopardize the adaptability of the URDG to the evolving operational context.

Two years in use, URDG 758 have achieved the status of a market standard. ICC will continue advocating for a universal use of URDG 758 especially in public procurement where the rigidity of governmental regulation made the acceptability of the rules more limited. The joint work currently in progress with The World Bank and the Asian Development Bank aiming to achieve a wider use of the URDG 758 is likely to enhance that prospect. l

Dr Georges Affaki is a member of the Executive Committee and Head of Structured Finance, Corporate and Investment Banking, Legal Affairs at BNP Paribas in Paris. He is Vice-Chair of the ICC Banking Commission and was Chair of the URDG Drafting Group. His e-mail is [email protected]

URDG 758 and The Guide ICC Uniform Rules for Demand Guarantees can both be ordered at www.iccbooks.com 

DCInsight Vol. 18 No.4 October - December 2012

Wanted: a more positive article 15

by Rupnarayan Bose

The expressions "reasonable time" and "without delay", because of their nonspecific nature, came under intense scrutiny during the drafting of UCP 600. "Without delay" survived, but the appearance of the expression "reasonable time" in sub-article 13(b) of UCP 500 was to be its last. The latter was removed completely from UCP 600. Five years on, few seem to feel its absence.

"Without delay" conveys a greater sense of urgency than "reasonable time". "Reasonable time" stretches the permitted time to an outer limit that could perhaps be justified under a given circumstance. Yet, both of the expressions are subjective in nature; neither indicates any definitive time frame nor a globally acceptable standard. It's debatable whether any period could, in all fairness, be set as a "reasonable time". Hence, it could not be part of any internationally applicable rules. If considered from a technical or legal point of view, a definite number of days was desirable. But even in its absence, most people preferred clear definitions and guidelines, blackand- white solutions over stipulations that were indefinite or vague in nature.

"Without delay"

The term "without delay" posed similar problems. A few members of the UCP 600 Drafting Group felt that the term should be disregarded, as were similar terms in the UCP such as "immediately" and "as soon as possible". This was because, like "reasonable time", "without delay" did not specify a definite period. Finally, it was decided to live with the expression, with the expectation that banks would act in accordance with the intent with which the words were used, i.e., expeditiously. In the final version of UCP 600, the expression "without delay" appears in six places.

The demand for setting a fixed number of days had its opponents. They insisted that the reason for having retained "reasonable time" in the UCP was that not every situation or circumstance could be envisaged in advance, rigidly defined or put in a straightjacket. The variety of credits was considered to be too complex. The inclusion of these expressions was said to convey a sense of responsibility and accountability. One view was that if the concept of "reasonable time" were removed, a bank might not take the initiative to examine the documents presented and to pay well before the maximum period allowed under a credit. The expression "reasonable time", they claimed, saved bankers from having to justify to either party why the applicant had to part with the funds earlier than the maximum period allowed, or why it took more than a day or two to honour the documents presented.

Clarity

Thus, the UCP 500 expression "shall each have a reasonable time, not to exceed seven banking days" allowed some leeway, with a built-in safeguard by way of a cap regarding the outer limit for the examination of documents. From the revised UCP 600 expression "shall each have a maximum of five banking days" (emphasis added), it could appear that ICC was not reducing the time from seven to five banking days; instead, it might be claimed that the available time was only being increased from a shorter time frame (guided by the circumstances of each case and practical considerations) to five days under the new UCP.

Even so, the majority of the Banking Commission members desired clarity. When the issue came up for a vote at the June 2005 Dublin Meeting of the Commission, all except one country voted for the removal of all references to the words "reasonable time". This made life easier for the Drafting Group, though the late Ole Malmqvist wrote: "For the Drafting Group, that was a nice clear decision, but I wonder if that change will lead to a general delay in payments to beneficiaries. If it does, we trade finance bankers will regret that we deleted it, and in a few years - fewer than if we retain the 'reasonable time' concept - we will have plenty of time to wonder why we did it."

Further steps

In addition to doing away with the undefinable concept of "reasonable time" in favour of a fixed number of days, the Drafting Group went a step further. It wrote into the rules a new article, article 15, titled "Complying presentation". This article states in clear terms what, until then, had been confined largely to considerations of "international standard banking practice". The new article now sought to delineate the responsibilities of a nominated bank, a confirming bank and an issuing bank on receipt of a complying presentation. Whether article 15, as it stands today, helps to add any value, any new dimension or rule to the existing practice, is debatable.

Any modification to the rules which helps to remove grey areas is always welcome. From that standpoint, although "without delay" remains, deletion of "reasonable time" was as welcome as the addition of article 15 to the rule book. The insertion of article 15 in the UCP is an instance of not relying wholly on international standard banking practice (yet another vague expression), but making the rules more specific.

A "black hole"?

What puzzles this writer is the reason why the Drafting Group did not take the provisions of article 15 to their logical conclusion. While they went to considerable lengths to eliminate and replace vague, non-specific phrases, they appear to have left a procedural "black hole" in article 15.

Sub-article 15 (a) states: "When an issuing bank determines that a presentation is complying, it must honour." Quite so! But the question is "When, within how many days?" What's the point of creating a so-called rule to tell the issuing bank that it must honour (nothing new there; the issuing bank is already bound by article 7 to do so), but stop short of stipulating a reasonable time for the same?

A similar question arises with regard to sub-article 15 (b). It states: "When a confirming bank determines that a presentation is complying, it must honour or negotiate and forward the documents to the issuing bank." Apart from the matter of forwarding documents, this sub-article simply repeats a section of sub-article 8 (a). The confirming bank is under no obligation or compulsion to negotiate within a "reasonable time" (similar to the issuing bank), or to forward the documents "without delay" to the issuing bank.

Sub-article 15 (c), the last in the trilogy, is stranger still. It states: "When a nominated bank determines that a presentation is complying and honours or negotiates, it must forward the documents to the confirming bank or issuing bank." Nothing unique here. It's acknowledged that a nominated bank is under no obligation to negotiate even if a presentation is complying. But what about its obligation to the presenter to either negotiate or to return the documents - all within a reasonable time, without delay? Is this too much to ask?

A remedy

Sub-article 7 (c) begins with the sentence: "An issuing bank undertakes to reimburse a nominated bank that has honoured or negotiated a complying presentation and forwarded the documents to the issuing bank." The absence of any mention of "reasonable time" or "without delay" here is not only perfectly acceptable and logical, but also eminently desirable. However, the issuing bank could face difficulty in refusing to honour or pay against reimbursement claims received after considerable delay (e.g., documents negotiated subsequent to a complying presentation, but received by the issuing bank, say, one or two years after the expiry or cancellation of a credit). In case of such refusals, the issuing bank has no protection today under the UCP. Under sub-article 7 (b), the issuing bank is "irrevocably bound" by its undertaking to honour. This undertaking is open-ended; it provides for a last date only for the presentation of documents (article 6), but none whatsoever for its expiry. Tweaking article 15 provides an opportunity to remedy this situation.

In its present form, article 15 hardly states anything that has not been stated elsewhere in the UCP. What it fails to do is spell out the obligations of the banks as conclusively as possible. For the reasons stated here, article 15 should be taken to its logical conclusion by adding either "reasonable time" or "without delay" to each of the three sub-articles. This would add a positive, decisive thrust to the rules and underscore the reason why "reasonable time" in the UCP was replaced in the first place with a definite period of time.

Rupnarayan Bose is former managing director of Fina Bank Ltd., Nairobi and TransAfrica Bank, Kampala. His website is http://www.rnbose.net, and his e-mail is [email protected] 

"The use of 'when' created an elegant solution"

by Dan Taylor

As a member of the Drafting Groups for the revision of UCP 400 and 500, I read with interest Rupnarayan Bose's article titled "Wanted: A more positive article 15".

The usage of the term "reasonable time" and the issues associated with it in the UCP are well-documented in numerous opinions of the Banking Commission and articles and, with the introduction of UCP 600, the expression is no longer a part of the rules. The use of the term "without delay" dates to the original 1933 (actually the 1929 draft) UCP and has been used in various ways in every UCP since. Based on its usage and understanding in relation to documentary credit processing, it has become a term of art for letter of credit practitioners and seems to be well understood to account for the variations in processing procedures.

As to the issues with the use of "When" in article 15, I would draw specific attention to the explanation in the Commentary on UCP 600 (Article-by-Article Analysis by the UCP 600 Drafting Group). I believe that these words clearly articulate the intentions of the Drafting Group.

"The essential word in each of the subarticles is 'when'. The introduction of this concept was necessary as a result of the removal from the UCP of the term 'reasonable time' in relation to examination of documents and the provision in article 14 of a maximum of five banking days following the day of presentation to determine compliance. The word 'when' does not mean immediately, but indicates that the process of honour or negotiation must begin. During the normal work flow for documentary credits, it can often take some time after the actual determination that the documents comply to conclude the processing of the transaction. This could range from an hour to a day, depending on the work flow and the time of day that the determination is made. Banks regularly have cut-off times for the processing of work late in the day, which can mean that an actual payment might not be effected until the following day."

The use of "when" created an elegant solution to connote the specific time when action should be taken and provides for the variations in processing.

Dan Taylor is Vice Chair of the ICC Banking Commission and Executive Director, TSS Global Market Infrastructures at J.P. Morgan in New York. He was a member of the UCP 600 Drafting Group. His e-mail is [email protected] jpmorgan.com 

Is the L/C really an independent undertaking?

DCInsight Vol. 18 No.4 October - December 2012

by Shahriar Masum

"Letter of credit is an independent undertaking"1

"A letter of credit is separate from the underlying sales contract"2

"Banks deal with documents and not with goods"3

"Banks examine documents on their face"4


These are some of the fundamental assumptions of letter of credit transactions. In fact, these are the assumptions that make the L/C what it is, namely:

a. a secured payment guarantee for the seller;

b. a secured and convenient guarantee product for the banks; and

c. a convenient payment mode for the buyer who does not need to pay in advance.

It's a win-win situation for all, and this is possible because of the independent nature of the L/C.

Autonomy at risk

But there are some scenarios in which the parties try to dilute this "Principle of Autonomy". The most common example occurs when a buyer tries to obtain an injunction5 prohibiting the L/C payment when the goods are not as per the sales contract. In this and other circumstances, it's perfectly valid to ask the question: "Is the letter of credit truly independent?" In an L/C, there are three related contracts:


1.  contract between the buyer and seller (i.e., sales contract);


2. a contract between the buyer and the issuing bank (i.e., L/C application); and


3. a contract between the issuing bank and the seller (i.e., letter of credit).


If parties 1 or 2 restrict the execution of the contract 3, the autonomy of the letter of credit is at stake. As noted above, the autonomy of the L/C is most commonly threatened by the opportunistic attitude of the buyer. If the buyer believes the seller has shipped defective goods, he may seek an injunction to stop payment under the L/C. Although in many cases courts will refrain from granting an injunction, there are exceptions. One is the so-called "fraud exception". In a historic court case6, Lord Denning, M.R. commented:


"A bank guarantee is very much like a letter of credit. The Courts will do their utmost to enforce it according to its terms. They will not, in the ordinary course of things, interfere by way of injunction to prevent its due implementation. Thus they refused in Malass v. British Imex Industries, Ltd., [1957] 2 Lloyd's Rep. 549. But that is not an absolute rule. Circumstances may arise such as to warrant interference by injunction [emphasis added]."


Seller's and beneficiary's fraud


One instance where an injunction is most likely involves a fraud by the seller. Justice Shientag7 put it this way:


"Where the seller's fraud has been called to the bank's attention before the drafts and documents have been presented for payment, the principle of the independence of the bank's obligation under the letter of credit should not be extended to protect the unscrupulous seller [emphasis added]."


By contrast, when we speak of beneficiary's fraud, there are two possible scenarios:


1. the beneficiary has not performed under the sales contract on which the L/C is based;


2. the beneficiary has performed under the sales contract, but has prepared some documents including false statements to meet the L/C requirements.


A difficulty arising from the comment of Justice Shientag is that it's unclear whether the case he referred to was one involving false documents or one of fraud in the underlying transaction. If the case is about the fraud in required documents under the L/C, then the principle of autonomy remains intact. But if it concerns the underlying transaction, the principle of autonomy of the L/C may be at issue.


While US courts have tended to extend the fraud exception to underlying transactions, UK courts are somewhat divided on the issue and often give great importance to the principle of autonomy. But there are contrasting decisions as well. In Edward Owen Engineering Ltd v. Barclays Bank International Ltd [1978], the fraud exception was characterized by Lord Denning as follows: "... the bank ought not to pay under the credit if it knows that the documents are forged or that the request for payment is made fraudulently in circumstances where there is no right to payment [emphasis added]." The italicized language in Lord Denning's formulation is broad enough to encompass the concept of fraud in the underlying transaction.


Establishing fraud


It must be remembered, however, that to obtain an injunction, a mere allegation of fraud is not sufficient; the buyer must have a claim for established fraud. In Discount Records Ltd v. Barclays Bank Ltd [1974], Justice Megarry refused to grant an injunction commenting: "In the present case there is, of course, no established fraud, but merely an allegation of fraud."


Another interesting case was that of Urquhart Lindsay & Co Ltd v Eastern Bank Ltd. [1922] in which Mr Rowlatt J ruled:


"the position of the bank under an irrevocable credit is in law the same as that of a person who has contracted to buy the shipping documents representing goods shipped, or to be shipped, under the contract between the beneficiary and the person at whose instance the credit has been issued [emphasis added]."


If indeed, banks purchase only the shipping documents and are in no way concerned with any other transaction, the Principle of Autonomy should still work, even taking account of the seller's fraudulent action, as long as the seller submits credit-complying documents. However, since the L/C is a conditional payment mechanism, created to facilitate trade transactions, the Principal of Autonomy will not work here. The courts have said that this is understandable and necessary to protect innocent parties. In fact, if a bank, with knowledge of established fraud, honours a fraudulent document, it may find itself a part of the seller's fraud8. In short, the L/C is not "fully independent" and depends, at least to some extent, on the actual performance of the seller under the sales contract.


Other cases


Interestingly, it's not always the buyer who wants to resist payment. There are cases where the buyer/applicant wants to waive discrepancies and wishes to pay, but the issuing bank refuses to accept the waiver and, due to discrepancies, does not make payment. Under UCP 600 subarticle 16 (c) (iii) (b), this is possible9. However, the UCP does not make clear the circumstances under which the issuing bank may refuse to accept a waiver from the applicant. Nevertheless, if the L/C is truly independent, this should be possible in all circumstances, since the L/C contract is only between the issuing bank and the seller. This was not the decision, however, in the case of Bombay Industries, Inc. V. Bank of New York [1995].


In this case, Bombay Industries Inc. (the L/C beneficiary) shipped goods to Collection Clothing Corporation (the L/C applicant) under a letter of credit issued by the Bank of New York (BNY). The presented documents were discrepant and were eventually refused by the bank. Later, the discrepancies were waived by the applicant, but the bank refused to accept the waiver as the applicant's credit line with the bank was cancelled. The court judged that BNY wrongfully dishonoured the presentation, since it considered matters outside the L/C transaction (i.e., the credit line of the applicant) when refusing the waiver.


Another bizarre case, International Dairy Queen, Inc. V. Bank of Wadley [1976], involved a bank that refused to pay because to honour the claim under the L/C, the issuer would have had to create a loan exceeding its capital adequacy ratio. In summary, the autonomy of the letter of credit does not always work, as courts tend to protect innocent parties. Applicants, banks and L/C beneficiaries, therefore, should not always consider the L/C to be the ultimate payment security. One also has to attach some not inconsiderable importance to the construction of the related contracts as well. Consider the words of Sir John Mcgaw in Bankers Trust Co. v. State Bank of India [1991]:


"The metaphor 'autonomous' means only that one does not read into any one of the four contracts the terms of any of the other three contracts. But the genesis and the aim of the transaction (Lord Wilberforce's words in another authority) are not to be ignored where they may be relevant to assist in the interpretation of the terms of the contract." l


Shahriar Masum is a Manager in MTB International Trade Services, Mutual Trust Bank in Dhaka, Bangladesh. His e-mail is [email protected]


1. In an independent undertaking, the party giving an undertaking conditions its promise on timely presentation of documents containing the required data.


2. Article 4 of UCP 600.


3. Article 5 of UCP 600.


4. Article 14 of UCP 600.


5. ICC has always upheld the independence principle of the L/C before the courts. In official Opinion TA 689 it said: "The issuing bank should now reconsider its position vis-à-vis the status of the presentation and approach the court for the order to be removed, thereby upholding the principles of the letter of credit product and the UCP, in particular article 5 and sub-articles 14 (a) and (h)."


6. Elian and Rabbath (trading as Elian & Rabbath) v. Matsas and Matsas; J.D. McLaren & Co. Ltd. And Midland Bank Ltd. [1966].


7. Sztejn v. J.Henry Schroeder Banking Corporation et al. [1941].


8. " ... a bank with knowledge of the beneficiary's fraud would itself be complicit were it to pay against them and require reimbursement from the applicant. Otherwise the autonomy principle prevails." Mr Paul Todd, "Bill of Lading and Banker's Documentary [email protected]"


9. As per UCP 600 sub-article 16 (c) (iii) (b), the issuing bank may not agree with the waiver given by the applicant. 

Asia takes centre stage in L/C markets

Extracted from DC Insights  Vol. 18 No.4 October - December 2012 by Mark Ford

Asia appears to be where it is all happening in terms of positive developments in the letter of credit (L/C) market. As Europe's banks retreat from some Asian markets, development banks are continuing to play a key role. Asia's banks are eyeing opportunities for L/C business in a new regional bloc, and China is intent on establishing renminbi (RMB) financing as a norm in international trade finance. 

These developments will likely spawn more regional L/C business and perhaps see Australia emerge as a major offshore renminbi trade finance hub. This, in turn, could shape the future of the global L/C market. 
Emerging markets 
In the wake of the 2008 global financial crisis, one driver of change that emerged in Asia's L/C market was the role development banks now play in support of L/Cs for Asia's least-developed countries. The International Finance Corporation's US$3 billion Global Trade Finance Program offers confirming banks partial or full guarantees covering payment risk on banks in the emerging markets for trade-related transactions, L/Cs included. The Asian Development Bank operates a similar program, which in 2011 was focused on Bangladesh, Nepal, Pakistan, Sri Lanka and Vietnam. 
Apart from these programs, other drivers in Asia's least-developed countries are likely to boost L/C business. One is the upcoming launch of the Asean Economic Community (AEC) in 2015. The central banks of all Asean countries are currently working to establish harmonious banking systems and drive financial service integration that will support intra-regional trading and investment. 
Full financial liberalization in the AEC is not expected until 2020, but progress is being made in creating a framework in which the services of some of the bloc's more sophisticated trade finance providers will become available in lessdeveloped countries. Negotiations on a common standard for Qualified Asean Banks (QABs) are underway. The idea is that QABs will be able to operate in every AEC country. 
Market opportunities 
This opens up opportunities for QABs headquartered in Asia's more mature financial markets such as Singapore and Malaysia to develop networks in countries with relatively undeveloped banking sectors that have often been closed to foreign banks. The banking sectors of the four least-developed AEC economies - Cambodia, Laos, Myanmar and Vietnam, collectively known as the CLMV - could offer QABs attractive expansion opportunities. 
Access to L/Cs across the CLMV is limited, reflecting their predominantly cash-based trading systems. Banks are few and far between, offering limited services. But even in the least developed markets such as Myanmar, at least four Thai banks are presently waiting for the authorities to allow foreign banks to set up joint ventures by 2014 and to open full banking operations by 2015. 
Developed countries 
There is also more scope for L/C product and market development in more developed economies. ICC, for example, has urged Thailand to open up its banking sector to allow foreign banks to write L/C and other trade finance business currently preserved for local banks. Jean-Guy Carrier, ICC's Secretary General, during a recent visit to Thailand, emphasized this point. He warned that while Thailand remains an attractive country for companies to do business, competitor countries such as Indonesia and Myanmar are honing their appeal to foreign investors. Recognizing the liberalization of Myanmar's economy and the liberation of opposition leader and Nobel laureate Aung San Suu Kyi, the US recently lifted import restrictions on a number of the country's products. ICC's Secretary General told Thai leaders: "You cannot afford to stand still while everybody is moving very fast to convince investors to do business. If you stand still, it means you are going backward." 
Thailand has made a start. In December 2011, the Bank of Thailand issued policy guidelines allowing foreign banks with branches in Thailand to convert to subsidiaries, albeit with a limited number of branches. 
Internationalizing the renminbi 
There are other positive developments. China's strategy for internationalizing the renminbi (RMB) looks likely to have substantial implications, not just for the regional L/C market, but also for the international monetary system and economies worldwide. 
The strategy has two planks: the creation of an RMB offshore market and, directly impacting on the L/C market, the use of the Chinese currency in international trade settlement. 
Since 2009, a series of policy measures have helped loosen the constraints of the currency's limited convertibility and provide the RMB offshore market with firm foundations on which to build and expand. Offshore market development depends on liquidity supplied by Beijing, but this is limited by China's lack of financial sector scope and sophistication, so the lion's share of funds flow to and from the mainland via Hong Kong. 
Hong Kong is seeing the most action when it comes to L/Cs. In May, data from SWIFT showed that the RMB had overtaken the Japanese yen to become the third-biggest currency by value in the global issuance of L/Cs. The US dollar retained the majority 84.4% share while the euro had a 7.0% share. 
Still, curious discrepancies have emerged. The SWIFT data showed that while the RMB gained a market share of just 0.34% of world currency payments, it captured a 4% market share in the global issuance of L/Cs. This appeared too high, prompting some analysts to suggest that L/Cs denominated in RMB were being used to bypass China's strict controls over the movement of capital by Chinese companies looking to borrow at cheaper rates than they can on mainland China. 
But even if some RMB L/Cs are used for nefarious reasons, they are still being employed increasingly for trade finance. This could have interesting repercussions for the world's elite stock of global trading hubs. 
Regional hubs 
Hong Kong will want to keep its position as a hub for the offshore RMB market and, perhaps crucially, it has the benefit of support from China's central government. Beijing is actively developing policies to make it attractive for foreign parties to conduct trade settlements in Hong Kong. These policies are expected to further secure Hong Kong's place as a major international trade finance centre. Singapore, where L/Cs abound because of the city-state's role as China's major commodities trading partner, is also fighting hard for RMB business. 
Meanwhile, some Australian bankers are excited about the impact the process of the RMB's internationalization could have on their business. One senior Australian trade financier told DCInsight that the process could catapult Australia's traditional financial hubs into major financial centres for Asia. 
Because of the massive volumes of bilateral Sino-Australian trade already in full flow, Australia has a significant competitive advantage in the international RMB market. As China relaxes restrictions on its currency, the conditions will ripen for RMB capital market opportunities, and few countries have such strong trade flows as the raw materials trade from Australia to China - with finished goods flowing the other way. Australia's case is strengthened by the withdrawal of European banks from their traditional financing roles. All of these conditions will spur opportunities for the issuance of RMB L/Cs or denominated debt issued by Australian banks in Chinese currency. 
Asia's trade finance markets are clearly in flux, and the ramifications of their growth will be felt in L/C markets worldwide. 

The EBRD and trade finance in Central and Eastern Europe

DCInsight Vol. 18 No.3 July - September 2012

by Kamola Makhmudova

The European Bank for Reconstruction and Development (EBRD) was established in 1991 in response to major changes in the political and economic climate in Central and Eastern Europe. Today the Bank works in 29 countries from Central Europe to Central Asia, and it is preparing to invest in countries in the southern and eastern Mediterranean region. The EBRD is a multinational institution set up with the specific aim of assisting countries to develop into market-oriented economies. Its 63 shareholders include countries from both the operational region and the rest of the world, plus the European Union and the European Investment Bank (EIB).





The TFP team: filling a trade finance gap

Public and private sectors


Aside from the EBRD's regional focus, one advantage of the Bank lies in its ability to operate in both the public and private sectors, and to have at its disposal the broadest range and flexibility of financing instruments. The Bank is equipped in its staff and range of instruments to support the different stages of transition. Specifically, the EBRD seeks to promote the development of the private sector within these economies through its investment operations, and through the mobilization of foreign and domestic capital.


The TFP


In 1999, the EBRD launched the Trade Facilitation Programme (TFP), the first of its kind. Since its creation, the TFP has helped companies in the EBRD's countries of operations to engage in trade, by providing guarantees for international trade transactions. By bringing liquidity to these markets, especially during challenging times, the Programme has enabled issuing banks to continue lending and companies to keep trading.


The Programme can guarantee any genuine trade transaction to, from and within the following 32 countries: Albania, Armenia, Azerbaijan, Belarus, Bosnia and Herzegovina, Bulgaria, Croatia, Egypt, Estonia, FYR Macedonia, Georgia, Hungary, Jordan, Kazakhstan, the Kyrgyz Republic, Latvia, Lithuania, Moldova, Mongolia, Montenegro, Morocco, Poland, Romania, Russia, Serbia, the Slovak Republic, Slovenia, Tajikistan, Tunisia, Turkey, Turkmenistan and Ukraine.


Since 1999, the TFP has facilitated more than 11,600 cross-border trade transactions worth a total of EUR 7 billion. The Programme is particularly active in the early transition countries (ETC). Banks in these countries will remain the key beneficiaries of the Programme in the foreseeable future.


The recently introduced TFP e-Learning Programme provides for the transfer of the latest know-how in trade finance and offers staff of active issuing banks up-to-date technical assistance and training that reflects the latest trends in the trade finance industry. The online courses are particularly popular among professional trade finance staff because they allow them to study in their own time and keep them up to date with the latest developments as additional courses are added.


Criteria


The TFP supports business based on the following specific selection criteria: terms and conditions must reflect sound banking risks, and private funding must not be available on reasonable terms. The project must be environmentally neutral or beneficial and socially responsible, as well as respectful of the rights and needs of communities.


One example of an intra-regional transaction was the import of industrial equipment for the manufacture of vehicles and trailers from Turkey to Russia in 2011. In this transaction, the NBD Bank in Nizhniy Novgorod issued a letter of credit that was confirmed by Commerzbank of Frankfurt, Germany. The EBRD provided Commerzbank with a guarantee for up to 100 per cent of the political and commercial payment risk.


One of the benefits of the TFP is the flexible nature of the Programme and the ability of the EBRD to combine forces with commercial partners to enhance their participation: for example, in 2011 a TFP guarantee was issued to cover 100 per cent of the payment risk of an advance payment guarantee issued by a Ukrainian bank to Deutsche Bank. Credit Suisse shares 35 per cent of the EBRD's risk.


This deal facilitated intraregional links and trade between Ukraine and Turkmenistan and was undertaken under market conditions where no commercial banks had the appetite to take risks. The EBRD successfully invited Credit Suisse to share 35 per cent of the EBRD's risk, demonstrating that the EBRD is ready to cover risk which cannot be covered wholly by the commercial market.


Results and outlook


The financial crises of 2008-09 led to a sharp reduction in world trade and trade finance, but around mid-2010 trade finance volumes in EBRD's countries of operations started to recover, and this upward trend continued well into the first half of 2011. Positive sentiment in trade finance was supported by robust economic growth in emerging markets, particularly outside Europe, as well as by rising commodity prices.


Commodity exporters, such as Kazakhstan, Mongolia and Russia, saw increases in trade flows, and also in some cases significant increases in capital inflows (with Russia being a notable exception). More broadly, increased consumer confidence in the region has led to an increase in domestic demand for consumer goods and an associated increase in imports.


Nevertheless, the market outlook for trade finance in 2012 is generally gloomy. The crisis in the eurozone is taking its toll, leading to more binding financial constraints, and is likely to further reduce the availability of commercial trade finance lines.


Banks in Central and Eastern Europe, in particular, will have to deal with reduced trade finance limits. Banks in countries which already had difficulties receiving sufficient lines before the latest financial turmoil are unlikely to receive new limits or limit increases for their trade finance business.


The latest ICC-IMF survey of almost 500 financial institutions worldwide confirmed a bleak picture for trade finance in 2012 (page 2 of this issue). Unsurprisingly, while the outlook for Asia is still relatively strong, the outlook for the eurozone was particularly weak. Almost 59 per cent of respondents in emerging Asia expect trade finance conditions to improve in 2012, while in the eurozone only 16 per cent envisage any improvement, and almost half of respondents expect things to get worse.


Central and Eastern Europe has the second-highest number of those with a pessimistic outlook, at 28 per cent. This pattern creates a bigger problem for global trade than first meets the eye. According to the survey, as much as half of the trade finance products offered by banks worldwide (ICC and IMF Market Snapshot, January 2012, based on December 2011 figures) come from eurozone banks. The latter's increased constraints could therefore have a negative impact globally on trade finance.


The main factor in the negative outlook stems from the reduced availability of credit at counterparty banks. This factor was singled out as a major risk by 42 per cent of respondents to the ICC-IMF survey. Many were also concerned about potentially shrinking demand for trade finance, both as a result of lower trade volumes (28 per cent of respondents) and a move to cash in advance transactions.


In short, in view of the ongoing economic challenge there is a certain need in the coming months and years for a facility that is well-supported, expertly equipped and well-positioned to promote, develop and underwrite trade among the growing economies of the early- and mid-transition countries of Central and Eastern Europe and Asia, and the southern Mediterranean region, and to draw in commercial partners with it in the process. The EBRD is ideally positioned to fulfil this, and the Trade Facilitation Programme is already demonstrating an enviable track record, in providing this role. It remains to be seen, however, just how much confidence can be built


Kamola Makhmudova is Principal Banker, TFP team, European Bank for Reconstruction and Development (EBRD). Her e-mail is [email protected]


Issuing banks and B/Ls consigned to order of themselves

DCInsight Vol. 18 No.3 July - September 2012

by Bob Ronai

Why do some L/C issuing banks require presentation of a B/L consigned to the order of themselves? This was a question I posted in an online group to get some discussion going. I realize that bankers have probably never really thought about the question. Presenting banks, nominated banks, confirming banks, any bank reading another bank's L/C simply accept that it is the issuing bank's instruction. The big question really is, has any issuing bank actually thought about it?

Ronai: "It is particularly annoying for shippers..."

I further explained in my post: "It is a particularly annoying (for shippers) requirement in many L/Cs that the issuing bank requires the B/L consigned to the order of themselves, often along with their full street address. It is in the best interests of shippers that they retain as much control over the title to the goods until the documents are correctly handed over to the buyer after the L/C drawing has been paid (or accepted) by the issuing bank.

"Is there a genuine reason for the B/L being consigned to the order of the issuing bank or is it just a bad habit picked up long ago and perpetuated by some banks because no one thinks about it or challenges them? Why is a full set of the B/L consigned to order and blank endorsed not sufficient?

"What extra protection does the issuing bank think it gives them? If the issuing bank advises that the presentation is discrepant and the applicant refuses the documents, what is the issuing bank's position re handing (and endorsing) the B/L on to another buyer of the beneficiary's choice?"

Bankers may well ask at this point: "So what, just do what the L/C says." We must remember, however, that L/Cs are not just a device to keep an inner circle of bankers amused or employed, but are a means of facilitating international trade. And international trade involves sellers and buyers who are not bankers. Moreover, the documents required by L/Cs include transport documents issued by carriers who are also not bankers.

Potential for error

Every time an L/C requires the B/L consigned to an issuing bank it adds work and potential for error. The beneficiary must ensure that its written instructions to the carrier are letterperfect, and then it must ensure that the carrier's B/L is letter-perfect too. Easy to say, but it means that the seller's and carrier's staff are dealing with names and words that will not be familiar to them.

Add to this, for reasons unknown, some issuing banks insist on including as part of the consignee details their full street address - complete with department name, office and level number, building name, cross streets and so on as if it were to be delivered by the mailman - and the margin for error grows considerably. Then the presenting bank's staff must provide their usual level of document checking, usually at least two different readings by two different people. How much time has been spent in this exercise for just one set of documents? Multiply that by thousands each day.

Beneficiary's point of view

From a beneficiary's point of view, why should the B/L be consigned to the issuing bank's order when it is not involved in the sales contract? Yes, the L/C itself constitutes a contract between the issuing bank and the beneficiary that the payment will only be made against presentation of complying documents which accompany a specified financial instrument, i.e., a sight draft or usance draft drawn on the specified bank, or by way of a deferred payment undertaking of the issuing bank. In other words, why should the issuing bank in any way be a party named in those shipping documents evidencing performance under the sales contract between the beneficiary and the applicant?

Possibility of rejection

The other point which concerned me, though admittedly its occurrence is quite unusual, is where, for some reason or other, a set of documents might be rejected by the issuing bank for a discrepancy and, in accordance with UCP 600 subarticle 16 (c) (iii) (a), the issuing bank is holding the documents pending further instructions from the presenter.

Let us say for example that the discrepancy was late shipment, and the applicant refuses to take up the documents because the price of the particular goods has moved downwards in the marketplace. Suppose the beneficiary finds another buyer and makes payment arrangements direct. And suppose the vessel is due to arrive at the destination any day. The expedient process is for the beneficiary to have his presenting bank instruct the issuing bank to hand the documents over to this new buyer. But the B/L is made out to the issuing bank's order. Will it be prepared to blank-endorse the full set of original B/Ls and hand it over to someone who is not its client? Having been named as the consignee on the B/L, does it want to accept any kind of responsibility or test it in a legal forum should the subsequent arrangements between the beneficiary and the new buyer later run into problems?

Responses to my question

Most of the responses to my question danced around the concept that the issuing bank required the B/Ls consigned to itself to secure its position should the applicant default, i.e., should the applicant have no money in its account when the complying presentation was received. This conjured up the scenario of a bank issuing L/Cs without full security - whether cash deposits, charges over existing assets or whatever - and hoping that its client would have enough wherewithall in the account on the day.

Would an issuing bank really be so foolish? And if the applicant did default, does the issuing bank want to be in the position of selling goods on the open market to recover its outlay? While it might be possible to do this for some freely traded commodity, how would the issuing bank dispose of specialty machinery spare parts destined for a failed project?

However, the main question remained without a satisfactory answer agreed to by all parties. What difference would it make to the issuing bank if the B/L was consigned to order and blank-endorsed? The bank would still be in possession of a title document which allows it to on-sell the goods if need be.

Lost in transit

ome comments referred to a situation of documents being lost in transit between the presenting bank and the issuing bank. The respondents seem to be concerned that not only would they go missing, but some unscrupulous party would conspire to somehow find those missing documents and use the B/L, consigned to order and blank-endorsed, to claim the goods from the carrier. Of course, this conveniently overlooks the need for import clearance of the goods through the importing country's Customs authorities, who will want to know why Company NN is attempting to clear goods addressed on all the documents as appearing to be bought by Company ABC. It presupposes that company NN could actually profit from taking delivery of those specialized spare parts. It also highlights that many bankers these days encourage a potentially dangerous practice of sending all documents in one lot.


Why is it that the bill of exchange or draft is almost invariably issued in both a first of exchange and a second of exchange, and B/Ls are issued usually in three originals? The answer, of course, is to allow the documents to be split into two separate but equally valid sets of originals, to be dispatched on separate days or by different means, such as by courier and by airmail.


The commonly seen reimbursement instruction that the issuing bank will remit payment upon receipt of the documents detailed in 46A of the L/C renders this procedure cumbersome at best and delays reimbursement at worst. Issuing banks probably need to re-think the wording of their bank-to-bank instructions to protect their applicants as well as themselves and the presenting banks.


Relevance


ISBP 681 in paragraph 184 also seems to support the contention that the issuing bank is not relevant to shipping documents by saying it need not be named as the consignee on certificates of origin. I would like to see the new ISBP include a paragraph stating that when an L/C requires a B/L consigned to order of the issuing bank, it is acceptable instead to present a B/L consigned to order and blank-endorsed. However, that idea was not accepted by the ISBP drafting committee, so I live in hope that, having now aired the topic to a wider audience, with enough thought given to the matter it might arise again in a subsequent revision.


No cohesive argument


To summarize, there seems to be no cohesive argument presented by banks which stands up to scrutiny to explain why this rather annoying and indeed unnecessary requirement has been adopted by L/C issuing banks. It seems to be based on the "it seemed like a good idea at the time" concept, which in turn is strengthened by the "that's how I was told to do it" excuse. So, I implore the bankers who read this article: please put a stop to this nonsense and only require B/Ls to be consigned to order and blank endorsed


Bob Ronai is the MD of Import-Export Services Pty Ltd, a company which specializes in export document preparation for its clients. He is a member of both the Banking and Incoterms committees of ICC Australia. His e-mail is [email protected]

A TRANSFER LC FRAUD CASE

DCInsight Vol. 18 No.3 July - September 2012

by King-tak Fung

A bank in Hong Kong issued a transferable L/C to the first beneficiary in Singapore. The L/C was available by negotiation with the transferring bank in Singapore and expired in Singapore on 6 February 2006. It was transferred to the second beneficiary in South Korea. The transferred L/C was also available by negotiation with the transferring bank in Singapore and expired in Singapore on 25 January 2006. The second beneficiary presented the documents that complied with the presentation and expiry date requirements of the transferred L/C to the transferring bank in Singapore on 18 January 2006.

King-tak Fung:"The banks should have asked … clients to produce the relevant evidence of fraud"

The first beneficiary refused to substitute any documents, and the transferring bank also refused to pass the secondary beneficiary's documents to the issuing bank for payment. (Note: as the second beneficiary failed to arrange the goods inspection as per the sales contract, both the first beneficiary and the applicant suspected it was a fraudulent transaction. The first beneficiary and applicant subsequently confirmed with the surveying company that the inspection certificates presented by the second beneficiary were forged documents.)

The transferring bank returned the documents to the presenting bank in South Korea without giving any reason, but suggested that the presenting bank present the documents directly to the issuing bank in Hong Kong.

The issuing bank received the documents from the presenting bank in South Korea on 2 February 2006 and rejected them on 3 February 2006 on the ground of discrepancies and returned the documents to the presenting bank. On 6 February 2006 (i.e., the expiry date of the master L/C), the presenting bank advised the issuing bank that it had received the revised documents in South Korea and alleged that the relevant presentation was therefore complying.

Key issues

When the transferring bank refused to handle the documents presented by the second beneficiary on 20 January 2006, where and when would have the transferred L/C expired?

i. in Singapore on 25 January 2006 (i.e., the expiry place and date of the transferred L/C)?

ii. in South Korea on 25 January 2006?

iii. in Hong Kong on 25 January 2006?

iv. in South Korea on 6 February 2006?

v. in Hong Kong on 6 February 2006 (i.e., the expiry place and date of the master L/C)?

Under UCP 500 and UCP 600, an L/C is available with both the issuing bank and the nominated bank. Accordingly, if the nominated bank refused to accept the nomination, the relevant L/C would be available with the issuing bank, which is obligated to effect payment under the L/C provided it received compliant documents on or before the latest presentation date or expiry date of the transferred L/C, whichever is earlier.

In this case, as the transferring bank refused to accept its nomination and to present the documents for the second beneficiary to the issuing bank, the transferred L/C therefore became available with the issuing bank in Hong Kong and expired in Hong Kong on 25 January 2006 (i.e., the expiry date of the transferred L/C). Since the first presentation was only received by the issuing bank in Hong Kong on 1 February 2006, seven days after the expiry date of the transferred L/C, the issuing bank was therefore entitled to refuse the presentation on the ground of late presentation. Consequently, the L/C expired.

Expiry place

The only possible exception to the above scenario would have occurred had the first beneficiary transferred the date and place of the expiry of the L/C from Singapore to South Korea as provided in sub-article 48 (j) of UCP 500. In that case, the transferred credit would have expired in South Korea on 25 January 2006. However, since the transferring bank did not transfer the date and place of expiry to South Korea, the transferred L/C expired in Hong Kong on 25 January 2006. Accordingly, the presentation of revised documents by the second beneficiary to its banker in South Korea on 6 February 2006 was non-complying, as it clearly went beyond the latest presentation and expiry date (i.e., 25 January 2006) of the transferred L/C. The position under UCP 600 (sub-article 38 (j)) would have been the same.

Expiry date

Is it arguable whether the transferred L/C expired on 6 February 2006 in Hong Kong (i.e., the same expiry date of the master L/C)? It is well settled that a second beneficiary is only entitled to the rights or interests transferred to it under the transferred L/C, nothing more.

Consequently, if the first beneficiary had decided not to substitute documents, the second beneficiary would only have been entitled to the transferred L/C dollar amount but not the full L/C amount (sub-article 48 (i) of UCP 500). It follows that the second beneficiary was not entitled to any rights or interests that had not been transferred to it under the transferred L/C, including the L/C amount and the expiry date. The position under UCP 600 (sub-article 38 (i)) would have been the same.

This is further supported by the fact that a second beneficiary generally has no knowledge of the terms of the master L/C, while the issuing bank can obtain the details of the transferred L/C from the transferring bank. It would obviously constitute a double standard if the second beneficiary were entitled to utilize the expiry date stipulated in the master L/C, but not the full amount of the L/C.

Reaction to forgeries

What should the transferring bank and issuing bank have done when the first beneficiary and applicant informed them respectively that the inspection certificates presented by the second beneficiary were forged documents? The banks should have asked their respective clients to produce the relevant evidence of fraud. If there is clear and obvious evidence to support a fraud allegation, it is a good practice for banks to alert other related parties in order to stop the alleged fraud before it is too late. For example, it would have been advisable for the transferring bank to inform the issuing and presenting banks that, based on the letters issued by the surveying company, the first beneficiary suspected the inspection certificates were fraudulent. This could have prevented the presenting bank from being deceived by the second beneficiary and also stopped the presenting bank from claiming that it had negotiated the documents in good faith and without notice of fraud.

Note that under UCP 600 a nominated bank that has effected a negotiation, prepayment, purchase or payment in good faith and without notice of fraud at the time of payment is protected and is entitled to seek reimbursement from the issuing bank, even if the presented documents are subsequently proved to be forgeries.

So long as there is clear and obvious evidence of fraud and the notice to other banks is carefully drafted, the risk of defamation will be minimal. In any event, if it turned out that the inspection certificates were forged documents, there would have been no defamation issue at all.

Could the documents be negotiated?

Could the presenting bank have negotiated the documents presented by the second beneficiary and sought reimbursement from the issuing bank in its own name? Since the transferred L/C was available with the transferring bank in Singapore by negotiation, the presenting bank in South Korea had no right to negotiate the documents presented by the second beneficiary under the L/C. Of course, it could have made a separate loan to the second beneficiary, but this would not have given the presenting bank any status or right to claim reimbursement from the issuing bank in its own name under the transferred L/C.

The presenting bank subsequently assigned the transferred L/C rights and benefits to an export insurance company in South Korea. Would the export insurance company obtain a better title than the presenting bank in lodging its claim against the issuing bank?

Although article 49 of UCP 500 permits assignment of L/C proceeds, it is well settled in English and Hong Kong law that an assignment of interest is subject to equity (i.e., an assignee cannot recover more than the assignor, and the defences of the debtor against the assignor are also available against the assignee.)

Accordingly, in the present case, the issuing bank was not obligated to reimburse the presenting bank, because there were discrepant documents, a late presentation and an expired L/C. These valid grounds of refusal, therefore, were also available against the assignee1. As a result, even if the assignment between the presenting bank and the export credit insurance company had been valid, the export credit insurance company would not have been entitled to claim payment or reimbursement from the issuing bank. This is because it cannot recover more than the presenting bank, which, as explained above, was not entitled to any payment under the transferred L/C.

The above views were, in the main, endorsed by the ICC DOCDEX experts (DOCDEX Decision No. 272) and the District Court of Seoul. Accordingly, the legal actions taken by the export insurance company against the issuing bank in South Korea failed. The presenting bank was ordered by the court to refund the credit insurance company

King-tak FUNG is a Banking Partner of Eversheds Hong Kong, a member of the ICC Consulting Groups on the UCP 500 revision and Forfaiting and author of Leading Court Cases on Letters of Credit (www.iccbooks.com) and UCP 600 - Legal Analysis and Case Studies (www.peer.com.hk). His e-mail is [email protected]

1Banco Santander SA v Banque Paribas [2002] Lloyd's Rep. Bank 165 (England).


Responses to catastrophic events under different ICC rules

DCInsight Vol. 18 No.3 July - September 2012
by Glenn Ransier

Each set of ICC rules addresses something known as force majeure ("FM"). But exactly what is an FM? Loosely defined, it is an event that forces an issuer's/guarantor's business to be interrupted and unexpectedly closed. If an FM is declared, then a bank may or may not have certain obligations depending on its role. For purposes of this article, I will concentrate on the views and practices for banks that have a responsibility to process undertakings, i.e., letters of credit and demand guarantees as defined in UCP 600, URDG 758 and ISP98 after an FM is declared, notwithstanding that FM is also covered in URR 725 (reimbursement) and URC 522 (collections).

Force majeure events

While ISP98 describes the event as a bank being closed for "any reason", UCP 600 and URDG 758 attempt to limit FM by providing examples, i.e., riots, acts of God, etc., and limit the times when an FM can be engaged by ensuring that the reason for a closure is due to a "cause beyond its (a bank's) control".

On 11 September 2001, the bank with which I was employed experienced an FM event when the building in which it was located, 7 World Trade Center in New York, was destroyed along with all its systems and files. While we resumed business within 24 hours, a few banks contested the FM stance we utilized upon our recovery. We ultimately prevailed in all the cases in which I was involved, but we were challenged nevertheless.

In my view, any major catastrophe can be deemed a FM event, and each rule set mentioned above appears to agree.

Lesser events

There are many other natural or other events that could cause FM to come into effect, including but not limited to, hurricanes, war, civil uprisings, etc. The possibility of these events occurring, which prevent a bank's employees from entering their workplace or their ability to process work, should give rise to FM protocols, to be engaged in accordance with an undertaking's applicable rule set and a bank's internal policies - for example, engaging a back-up site, notifying clients and/or courier companies of your new address, etc. However, what happens in the case of lesser events? What if, say, a bank caused a strike by significantly undervaluing its workers or caused its own building to fall into disrepair and fail by not following recommended maintenance procedures? Are these events outside of a bank's control?

What's outside of a bank's control is certainly open for debate. There have been and continue to be court cases on the matter. Some examples include: Choctaw Generation Ltd Partnership v. American Home Assurance Co. 2001 U.S. App. LEXIS24809 (2d Cir.) [U.S.A.]; or Procter&Gamble Cellulose Co. v. Investbanka Beograd; 98 Civ. 2359; 2000 U.S. Dist. LEXIS 5636 (S.D.N.Y. 1 May 2000) [U.S.A.]; or Fortis Bank v. Indian Overseas Bank, [2010] EWHC 84 (Comm) [Eng.] (Note: In this case experts were used to discuss force majeure.)

Immediate actions

Should an event occur that would necessitate a bank citing FM, a bank must review each outstanding undertaking it has either issued or confirmed and determine which rule set governs it. The reason for this is simple: each of the three rule sets named above mandate very different approaches, actions or inactions.

UCP 600 article 36 states: "A bank assumes no liability or responsibility arising out of the interruption of its business by ... A bank will not upon resumption of its business, honour or negotiate under a credit that expired during such interruption of its business." While it may not appear fair, this rule effectively allows a bank to end its irrevocable obligation if an FM event occurs, or does it?

URDG 758 sub-article 26 (b): "Should the guarantee expire at a time when presentation or "payment" ... is prevented ... i. each of the guarantee and any counterguarantee shall be extended for a period of 30 calendar days from the date on which it would otherwise have expired, and the guarantor shall as soon as practicable inform the instructing party ... " [emphasis added]. Unlike UCP 600, URDG 758 mandates an extension of the undertaking for 30 calendar days from its current expiration date and includes an obligation to notify other parties in the unlikely event that the guarantor hasn't re-established its trade operations within 30 calendar days. Then, like UCP 600, its obligations cease.

Under ISP98 Rule 3.14 (a): "If on the last business day for presentation the place for presentation ... then the last day for presentation is automatically extended to the day occurring thirty calendar days after the place for presentation re-opens for business ... " [emphasis added]. Additionally, ISP98 allows a bank to designate "another reasonable place for presentation".

For undertakings subject to ISP98, whether issued or confirmed, a bank may decide to notify the various parties of the new place of presentation. If not, a bank is expected to clearly make known the day upon which it resumed business, because in these rules the "last day for presentation is automatically extended to the day occurring thirty calendar days after the place for presentation re-opens for business" [emphasis added].

Disparities

One must note the interesting disparity between the rules on so basic a level. Commercial L/Cs, which generally are primary payment undertakings governed by UCP 600 to cover a movement of cargo, have the most to lose if a FM event is declared, whereas demand guarantees subject to URDG 758 and standby L/Cs subject to ISP98, both of which generally provide a secondary payment obligation, have ongoing duties. When the drafters of UCP 600 attempted to remedy this disparity, the ICC Banking Commission overruled them.

While two of the rule sets, URDG 758 and ISP98, discuss what happens in the event "presentation" cannot be made due to a FM event, only URDG 758 specifically looks at the examination and payment obligations that also become affected by such an event. Some examples include: (a) documents received prior to the FM event but not yet fully examined; and (b) documents examined by the issuer, deemed compliant but not yet paid.

URDG 758 article 26 (b) clearly articulates the actions needed in these situations: "ii. the running of the time for examination ... made but not yet examined ... shall be suspended until the resumption of the guarantor's business"; and "iii. a complying demand...presented before the force majeure but not paid ... shall be paid when the force majeure ceases even if that guarantee has expired... ".

URDG 758 is certainly the most comprehensive rule set where FM is concerned. An issuer which has closed due to an FM event has a number of obligations to maintain and actions to take. Because of this, beneficiaries and guarantors (secured by a counter guaranty) receive the most protection.

ISP98's FM rule appears to concentrate its focus on presentation of documents and does not delve into these documents or payments in process. This is left for interpretation and negotiation.

UCP 600 indicates that issuers will not honour or negotiate a letter of credit which expired during a FM event. "Honour" and "negotiation" are both defined terms in the UCP. However, one must wonder if a bank could be truly relieved of irrevocable obligations when it found documents to be complying and then either honoured a time draft by accepting it, or by creating a deferred payment obligation, or having negotiated it by committing to a fixed future payment. What would govern in these situations - L/C rules? L/C laws (if any)? laws for negotiable instruments? I note that even though my former employer was affected by the events of 9/11, we made a business decision not to find out how much protection the UCP offered. Rather, we promptly paid these types of obligations upon re-establishing our trade business.

Only one party

In many instances, only one banking party is affected by an FM event and not the other. The other, non-affected bank still retains its irrevocable obligations. The key is to remember to claim or present documents to that other bank ASAP. As a reminder, L/Cs governed by UCP 600 often nominate "any bank" to negotiate, so presentation does not need to occur at a confirming bank's counters, but rather "any bank's".

In closing

We have recently seen a series of FM events - a nuclear disaster in Japan, Hurricane Carlotta in Mexico, ongoing wildfires in the US state of Colorado, an armed conflict between South Sudan and the Republic of Sudan, etc. These kinds of events will never entirely disappear. While often one cannot prepare for the suddenness with which they occur, one can take steps to understand his rights and obligations should he find himself affected by such an event

Glenn Ransier is the Director Trade Finance Operations with ABNAMRO Capital USA. He was a member of the URDG Drafting Group and the Demand Guarantee Task Force. The views expressed are his personal views and do not necessarily reflect those of ABNAMRO. His e-mail is [email protected]

Bad faith and unconscionability

Extracted from DCInsight Vol. 18 No.3 July - September 2012

by John F. Dolan

There are grave and underestimated perils in bringing the doctrines of good faith and unconscionability into letter of credit (or independent guarantee) law and practice, yet some courts, especially in a few Asian jurisdictions, seem willing to accept such doctrines, which alter the nature of an independent undertaking and render it an entirely different commercial device.

Dolan: "those doctrines destroy the independence of the obligation"

No one is comfortable arguing that applicants or bank issuers have the right to behave in bad faith or unconscionably (1) when deciding to dishonour the beneficiary's demand for payment or (2) when honouring the beneficiary's demand for payment in the face of the applicant's claim that the beneficiary has breached his underlying agreement with the applicant.

In fact, of course, the conclusion that those who defend the doctrine of strict documentary compliance or who support the doctrine that the issuing bank's obligation on an independent undertaking is independent of the underlying transaction are not arguing that applicants or banks have a right to behave in bad faith or unconscionably. They are arguing simply that bad faith and unconscionability analysis have no place in independent undertakings litigation, for those doctrines destroy the independence of the obligation. Unfortunately, these issues do not always lend themselves to rational discussion.

Bad faith

Bad faith is the absence of good faith and, in law, is usually activity that is dishonest or constitutes a failure to observe reasonable standards of fairness in the industry. It is nice to say that everyone should act in good faith, and efforts to keep the good faith notion out of letter of credit law distresses some, who see the rules as devices by banks to oppress commercial parties. The US Uniform Commercial Code, Article 5 defines "good faith" as honesty in fact. Under this definition that excludes the "reasonableness" standard, arguments that a party should know reasonable standards of fairness in the industry when there are no such standards or when the beneficiary or applicant is reaching to find them, will not work in letter of credit litigation.

When markets were local, it may have been that a New York buyer who rejected a Chicago seller's shipment of sweaters, 12 to a 10-sweater box, may have violated standards of fairness in the garment industry. Today, garments shipped to New York more likely come from Bangkok than Chicago, and chances that there are any standards of fairness in that global industry or most other global industries is unlikely. Testimony of such standards is testimony of ersatz standards that appeal to the expert witness's views of what parties in the garment trade should do.

The "good faith" issue often arises when an issuer dishonours the credit on the grounds that the beneficiary's documents are defective. In Mannesman Handel AG v. Kaunlaran Shipping Corp., applying Swiss law, the Court of Queen's Bench rejected the issuer's argument that the beneficiary's deficient documents justified its dishonour. Applying the good faith and abus du droit provisions of the Swiss Civil Code, the court ruled that the issuer knew or should have known details of a related transaction, and that payment it had received under a separate credit rendered its dishonour of the non-complying presentation an act of bad faith. The ruling destroys the independence of the credit and imposes investigative and lawyerly duties on document examiners.

When an issuing bank's document examiners determine that documents do not comply, they must next decide whether to honour or dishonour. Most of the time, the bankers will ask the applicant whether it wants to waive the defects and take the documents. Studies suggest that in most cases the applicant will waive them. The applicant wants the goods, the documentary defects notwithstanding.

Occasionally, however, the issuer will not ask for the waiver or will ignore it. If the issuer is concerned that the applicant's financial condition renders reimbursement unlikely, the issuer may choose to dishonour. That decision will strike many as one taken in bad faith. There is nothing dishonest in taking that position, however; those who understand letter of credit practice know that it is not bad faith for the issuer to enforce the conditions of the credit and, more importantly, know that when courts open the question in a few cases they render litigation highly probable in many others.

Litigation drawbacks

Increasing the likelihood of litigation is always a recipe for disaster. It increases costs and is always a burden in commercial transactions. When certainty suffers, costs rise. The commercial party that knows what it is doing knows that presenting non-compliant documents puts it at the mercy of the issuer. And the applicant ends up paying more as a subsidy for the feckless beneficiary that looks for relief when it fails to present complying documents.

Adoption of a good faith standard, moreover, runs the risk that experts who know better will temper their testimony. "Are you telling the court (or the arbitrator) that the issuing bank has the right to dishonour when the beneficiary presents a copy and not the original of an inspection certificate?" The answer should be an unqualified "yes", but many experts are reluctant to give that unqualified answer.

The answer to the question may in the minds of some depend on the consequence of the missing original. Yet, the answer is "yes", because the issuing bank should not be required to know the consequences of the defect and should not be allowed to consider the consequences. Document examination is a ministerial process, and that process does not entail equitable considerations. The issue should be only whether the documents are compliant.

Unconscionability

Unconscionability is the practice of taking unfair advantage of another party. Some courts view a bona fide dispute in the underlying transaction as grounds to forbid payment of the credit, on the grounds that under such circumstances, payment is unconscionable.

This issue arises when the applicant wants the issuer to dishonour facially compliant documents. In an illustrative case, Dauphin Offshore Engineering & Trading Pte Ltd. v. Private Office, a yacht builder and its buyer disputed the quality of the builder's performance of the yacht building contract. When the buyer drew on an independent bank guarantee to recover installment payments, the court held squarely that if payment under the guarantee was unconscionable, the court could enjoin it. The court made it clear that unconscionability is different from fraud and depends on the facts of each case. Thus, the court would allow a stop payment order, and the buyer, who should receive payment under the bank's obligation not more than five banking days after presentment of complying documents, would have to wait as long as a year or more in some jurisdictions for his money and would have to convince the trial court that his draw is not unconscionable, whatever that means, all before he recoups his installment.

Violating the independence principle

Avoiding that delay and avoiding the need to litigate without the funds are the two chief objectives of the independent bank guarantee and the standby.

Courts in trading nations have fashioned high thresholds for judicial relief for the applicant that claims fraud. Though in some jurisdictions courts are not vigorous in applying this rule, the applicant alleging fraud has a difficult time stopping payment in most important trading states. Courts in these states recognize that by forcing the beneficiary to litigate the fraud issue, the applicant is destroying the independent obligation as an effective commercial device and valuable bank product.

Regrettably, some courts, such as in the Dauphin Offshore Engineering case, now decline to enforce the credit when there is a bona fide dispute over contract performance. In that case, the court concluded that it was appropriate to stop the payment and permit the applicant to litigate the underlying contract issues before the beneficiary could obtain its money. Traditional letter of credit law allows the issuer to pay and forces the applicant to sue the beneficiary for breach of contract post payment. The new argument is not a "fraud" argument but an "unconscionability" one, which is not subject to the limits courts and legislatures have fashioned to prevent the fraud exception from destroying the viability of independent obligations.

Unconscionability argument akin to bad faith. It is the notion that by drawing, the beneficiary is taking unfair advantage of the applicant. Making that determination prepayment violates the independence principle that is the chief advantage of the standby and the independent bank guarantee as commercial devices, retards payment and reverses the character of these obligations from a "pay-now, argue-later" device to an "argue-now, pay-later" device, in effect transmuting the independent guarantee or credit into a dependent undertaking, a bond.

The introduction of the broad "good faith" definition or the unconscionability concept into letter of credit law disables the letter of credit. Those concepts destroy the credit's nature as an independent credit enhancement device that commercial parties should be able to choose to support their relationships. To destroy the letter of credit in this fashion is to leave many traders and borrowers with no device to gain entreé to markets.

Independent bank undertakings are crucial to trade and commerce. If courts take them away, we will have to invent "something new that is just like them", and that something will have to be available without regard for the concepts of good faith or unconscionability

John F. Dolan is Distinguished Professor of Law, Wayne State University, Detroit, Michigan, USA. His e mail is [email protected]


The eurozone crisis: its impact on L/Cs

Extracted from DCInsight Vol. 18 No.3 July - September 2012

By Mark ford

Greece edged back from the brink of falling from the eurozone in mid-June when Greek voters chose austerity over life outside the European currency. But the relief that followed the election result was fleeting and unlikely to restore confidence in Greek letters of credit, which had been lost before the polls. At the time of this writing, scepticism remained over the country's ability to sustain eurozone membership.

But now the focus has broadened, dwelling on the debts of Portugal, Ireland, Italy, Greece and Spain (the PIIGS). A handful of smaller eurozone members and banks also have the potential to further shake the foundations Europe's financial system on which L/C business is written.


It looks like time to brace for change. If the impact of Greece's tribulations on its L/C market was devastating, it will be more so if confidence in Europe's larger economies to pay their debts fails, while the most serious impacts of the European currency crisis on the L/C market may have yet to be revealed.

Politicians are hopeful that steps taken at the June EU meeting - which included allowing direct fund injections into Spanish banks and a plan to set up a central EU banking regulatory authority

- will turn things around. But full details have yet to be worked out and uncertainties remain concerning where the money is coming from.

Meanwhile, the repercussions of the crisis are already being felt or anticipated in L/C markets from the US and Latin America to Africa and Asia.


L/C system short-circuited

An L/C shortage has forced Greece into tight corners, and despite the election result, it is hard to see how the country's former L/C users will find a way back from the cash up front or open account arrangements with hefty premiums now demanded by suppliers.


Greece's largest oil refining company, Hellenic Petroleum, which has long relied on Iranian oil paid for on L/C terms, can no longer do so and has to look elsewhere for oil owing to international sanctions and payment terms because of the lack of L/Cs.


Glencore and Vitol are reportedly stepping into the breach, but due to the shortage of L/Cs, Hellenic will have to pay hefty premiums on the oil they buy from the Swiss commodity houses that have extended about EUR 300 million credit and are prepared to deal on open account terms with no L/Cs or bank guarantees. Hellenic's fuel bill will increase dramatically.


Even established and profitable traders are stymied. Unable to obtain L/Cs, they are forced to pay cash up front. Successful traders who have explored the option of moving to non-Greek banks say financial institutions in safer European countries refuse to write L/C business because they can issue no kind of guarantee on businesses incorporated in Greece. This raises the prospect of owners of profitable businesses with customers waiting, selling up to buyers in countries not barred from the L/C market.


Bankers canvassed by DCInsight say the election result will not make a substantial difference in this situation, since confidence in Greek banks' ability to back the credit of even sound Greek businesses is already lost.


"The system has already shortcircuited, and the revolving trade finance that kept Greek companies in the game is gone unless and until the issuer of the currency, the European Central Bank (ECB) steps in to underwrite the [currency] union, regardless of whether this is in Greece, Spain, Italy or any other country in the eurozone," according to one Dutch banker.


If the Greek experience is replicated in the much larger economies of Italy and Spain, the impact on the European L/C market will be huge. But problems could come from less likely places. It is easy to overlook countries such as Slovakia and Cyprus, which have very high debt relative to the size of their economies.


Impacts beyond Europe


One successful Irish company's experience shows how wider problems in the PIIGS banking system impact on global L/C flows. Dublin-based Cush'n Shade was supplying some of the US' largest retailers, but says it has been forced into voluntary liquidation. It cannot obtain credit from the Bank of Ireland for the working capital needed to manufacture its products despite having L/Cs from its US buyers ready and waiting.


In terms of trade finance, it is now clear from the example of Greece what happens to countries that could drop out of the eurozone. But a systemic failure in the European financial sector on the L/C market would impact way beyond the basic buyer-seller transactions already discussed. A key question is whether failures to meet debt obligations amongst the PIIGS (or elsewhere) could cause major European bank failures.

For this to come about, two things would probably have to happen: an EU member state would have to default on its debt and withdraw from the eurozone, and the ECB would have to refuse support for European banks that would almost certainly be left reeling if any member state withdrew from the zone.

Spanish bank collapses could be perilous for Latin American as well as European banks in the same way as Portuguese bank failures could affect banks in Brazil and Angola. A crisis in the European banking sector could also prompt credit downgrades on US banks. This could push up the price of L/Cs that currently support US variable-rate demand bonds.

Chinese exporters are seeing fewer L/Cs available from European banks and are taking into account the prospect of Italian and Spanish banks exiting the Sino-European trade finance market if serious financial sector restructuring in those countries is needed.

New suppliers and market dynamics

The eurozone crisis may precipitate changes in the players in the global L/C market as well as the way business is conducted in that market.

The International Finance Corporation (IFC) says it will expand its existing L/C programmes to replace European banks withdrawing from emerging markets. As the IFC's outgoing CEO, Lars Thunnel, points out, less-developed countries are particularly reliant on banks for trade support because they depend on bank-financed L/Cs.

European banks will also see the pace of erosion of their dominant role financing Asia's trade accelerated by the fast growth of renminbi (RMB)- denominated L/C trades. According to SWIFT, the RMB and not the Japanese yen is now the third-largest currency in the global issuance of L/Cs by value, after the US dollar and the euro. Chinese, Korean and Japanese financial institutions are seeing the opportunity to step in to replace European banks in Asia and other emerging markets. They have trade finance in their sights.

If economies such as Greece pull back from the brink and banks are bailed out at the eleventh hour, the eurozone may muddle on. In this scenario, negative impacts on the L/C market may be severe only in highly indebted countries, although global L/C flows will be affected too.

A continuation of European banks ceding market positions in global trade finance to other players can be anticipated, and this process will accelerate if the eurozone crisis worsens. But if more economies suffer the fate of Greece and its L/C market, then the scale of the problem for the documentary credit industry could well reflect the size of the economies affected. Worse still, if a country exits the eurozone and major banks are allowed to fail, it would almost certainly be time to brace for unprecedented change in L/C markets


Mark Ford's e-mail is [email protected]


Trade finance: facing "the five Cs"

 

Comedy icons Laurel and Hardy had a way of finding themselves in trouble. "Well, here's another nice mess you've got me into," Hardy would always say. "Another fine mess" is a fair description of our current situation in trade finance.

Since the 2008/9 crisis, challenges and pressures in the business have only intensified. What I categorize as "The Five Cs" - Capital, Credit, Costs, Competencies and Compliance - have converged to make this the most challenging time in trade finance history.

Capital

ICC's Banking Commission and other banking associations around the world have worked with the Basel Committee on Bank Supervision (BCBS) to bring much-needed additional capital into the banking system while preserving the banking community's ability to provide trade finance. This effort was dealt a blow in October, when the BCBS decided to retain the Credit Conversion Factor at 100% for letters of credit and other trade related instruments. Under former regulatory regimes, trade instruments were at 20% to 50% (see the article on Development banks in this issue).

While consistent with the Basel Committee's broader transparency objective, this move from "off balance sheet" to "on balance sheet" transactions penalizes trade transactions, which run an infinitesimal risk of being brought onto the lender's balance sheet due to default.

To reduce systemic risk and discourage interbank lending, the BCBS has added a capital premium to credit exposure for financial institutions with balance sheets of over $100 billion. Some exposures between banks can grow toxic in times of economic upheaval, but L/C confirmations and short-term refinancing of trade transactions are not among them. ICC has done two exhaustive studies analyzing the default rates of trade finance transactions. Both studies, which encompass the most severe economic downturn since the Great Depression, confirm that trade as an asset class is the safest form of lending, with defaults of less than 1% over the past six years.

Credit

An unintended consequence of increased capital requirements is the possible reduction of available credit, which may force banks to make tradeoffs among products, customers and transactions. A higher capital allocation for exposure to other banks will, in all probability, reduce the amount of credit extended to that segment. The historic reliance of banks in the developing world upon developed-world banks for trade finance will be challenged by this reallocation. Developing world customers, particularly SMEs, will be denied the credit they need to build their businesses, increase employment and contribute to economic development, essential to raising the country's overall standard of living. When regulators implement new capital standards in order to improve control over the financial markets, the ironic result may be that credit-challenged banks and companies are driven to seek financing from unregulated entities.

Costs

For the past 20 years, industries, including banking, have been reducing unit costs by moving labor-intensive, redundant activities to low-cost countries. This has proven to be mutually beneficial, with industries maintaining their competitiveness while host countries create jobs and the opportunity for broad economic development. As labour cost differentials have diminished, however, competition for resources has increased, with the result that industries have moved their offshore processes to the next low-cost country.

Enabled by imaging technology, the trade finance industry has done its best to capitalize on this phenomenon, moving its most costly component of production - documents examination - to countries with low-cost, trainable labour. By making the process binary - "Does the document comply or not?" - trade providers have been able to isolate potential discrepancies and escalate them to subject matter experts in the "sending" country for honour or rejection.

Eventually, like other cost-cutting businesses, trade finance processors have migrated to the next low-cost country. But there are now few, if any, "next" countries. There may be one or two more stops on the unit cost benefits train, but the ride may no longer be worth continuing.

Competencies

Historically, trade finance professionals have viewed their jobs as a vocation, striving to deepen their knowledge through years of experience. In the new low-cost model, they have kept their critical analysis and decision-making responsibilities, but do not control the end-to-end review. The experts' lack of ownership of the process and narrowing of responsibilities has made it more difficult for trade finance providers to retain them.

The pipeline of trade professionals has also dried up. Our predecessors were weaned on the understanding that in all likelihood they could develop on a career path similar to the guild system of moving from apprentice to journeyman to master. The current crop of candidates expects to check the box at each level of the process, quickly rising to mastery (or familiarity, at least), and then move on to another product or activity without being "typed" as a trade finance expert over a career of twenty years.

There is another problem related to finding new talent: the technology component in traditional trade processes is low, providing no stimulus for children of the Internet. Because of their near instant access to information, younger finance professionals lack the curiosity and sense of discovery needed to work effectively with trade transactions. Before the world was connected as it is today, you could use your imagination to understand the marvels of international commerce and marvel at the intricate processes that brought materials and goods from one end of the world to the other. Today, there is no need to imagine these things. You can view the same processes in real time on a number of web sites or even YouTube.

Compliance

Already made costly enough by labour, trade finance has been made more so by compliance. Compliance was once the diligent examination of documents integral to completion of a cross border transaction: keeping an eye out for boycott language, for the involvement of just four embargoed countries and for a relatively short list of "bad guys." Nowadays, the examination of documents requires extensive screening (against multiple-country lists) of numerous data elements embedded in ancillary documents, regardless of their role in the letter of credit process.

As database technologies advance, software will execute this screening, but most data elements will need to be transferred manually. Mis-keying of data can result in a false hit - or worse yet, conceal a valid hit. Of even greater concern is the lack of consistency amongst the various country requirements. What may be permissible in one country turns out to be illegal in another, making banks vulnerable to massive fines or even criminal proceedings.

Compliance challenges go beyond transaction processing. Know Your Customer standards vary from country to country, causing disruptions to the free flow of cross-border transactions. A party from one jurisdiction may not be not be vetted appropriately within the counterparty's jurisdiction. Until remediation is completed, the transaction is delayed and supply chain disruption is the likely result.

Meeting "the Five Cs"

Given these five challenges and their historic convergence, what are the next steps for trade finance?

Here are a few: the banking community must move its lobbying effort from Basel to local regulators who will be implementing the new rules. It is even more important to sound the alarm amongst customers who will be facing higher costs for their trade finance, if it is available to them at all. In order to raise the next crop of trade professionals, the industry must find a way to restore the critical aspects of "vocation" without creating an even costlier environment. One way of doing this is to leverage major trade finance providers to reduce competition for resources in what are considered to be "best" locations.

We must also continue to work to make trade finance simpler and cheaper to provide through automation and streamlined, harmonized processes. The industry should do what is needed to speed the migration from paper document checking by promoting the use of new tools like SWIFT's Trade Services Utility (TSU) and Bank Payment Obligation (BPO). As new moves to offshore processing make less sense, the industry should instead get serious about capturing cost savings through continued technological innovation, better training and acknowledgment that slow cost increases are tolerable when we are improving quality and stability.

Finally, in these very volatile times the ICC membership and other trade finance stakeholders must do what is necessary to ensure that multilateral agencies such as the International Finance Corporation (IFC) and the Asian Development Bank (ADB) stand ready to help developing world banks provide trade finance in the event of a major constriction.

In the 1930s, movie audiences were always delighted to see Laurel and Hardy in one more mess. Trade finance customers cannot be expected to feel the same way about seeing us in our current situation. It is up to the community to do everything possible to ensure that the world's oldest commercial activity continues to receive the funding and expert support it so desperately needs - and has every right to expect of us. l

Michael F. Quinn is Managing Director of J.P. Morgan Global Trade in New York. His e-mail is [email protected]

 

 

New uniform rules near completion

 

DCInsight Vol. 17 No.4 October - December 2011

 

by Sean Edwards

It's some time since readers of DCInsight were informed of the project between ICC and the International Forfaiting Association (IFA) to produce a set of rules for the forfaiting market. That project, after considerable effort from all involved, is now close to a successful conclusion and is expected to be launched in the first quarter of 2012. A consultative panel from the ICC has provided valuable comments with additional and equally helpful comments from ICC national committees.

The rules - to be known as the Uniform Rules for Forfaiting (URF) - mark an important development for ICC as well as the IFA, as they concern not just a single product, such as letters of credit or demand guarantees, but a whole industry. The URF will "sit on top" of the underlying transactions (letters of credit, negotiable instruments, obligations to pay, etc.) being created or traded and, by doing so, will create value and marketability. In short, the URF is about providing finance and not simply a payment mechanism. In the current climate, finding the most efficient way to fund trade is a duty none of us can shirk, and the URF is an important contribution to the tool kit of trade finance bankers.

Objectives

Forfaiting, traditionally defined as the non-recourse discounting of trade-related payment instruments, principally promissory notes, bills of exchange and letters of credit, originated in the immediate post-World War II period to help finance reconstruction in Europe. More recently, forfaiters have cast their net more widely and have been active in developing new markets in emerging countries and creating innovative structures.

The URF is designed with one eye on developing those markets and builds on the Market Practice Guidelines (a guide and model master agreement for the secondary market) and the Guide to the Primary Market by establishing a set of rules for both markets. The URF deals with the needs of the two markets by employing mirror provisions for the two markets amended only where necessary to take account of structural or commercial differences. A number of common provisions are then introduced. The result is, hopefully, clarity and transparency for both markets.

Themes

Although the final version of the URF has not yet been agreed, the major themes have been fixed and largely agreed, so it is not premature to discuss the most important concepts dealt with in the document.

The first, and a subject familiar to letter of credit specialists, is the question of what constitutes satisfactory documentation. In the URF, the rules in this regard are more general and permissive than those in the UCP and for good reason. Because the URF is concerned with marketability, the provisions on satisfactory documentation generally intervene at the point after the instrument has been created. So, for example, a letter of credit that is being forfaited would have had to satisfy the UCP in order to be forfaitable, but would also have to pass through the URF tests to become marketable. Therefore, the focus in the URF is on authenticity, legality and enforceability of the relevant instruments.

In the primary market, these factors are the basic starting point, whereas for the secondary market they are, subject to individually agreed requirements, final and exhaustive. This reflects a basic feature of the forfaiting market in that originators of transactions, or Primary Forfaiters as they are known, bear increased responsibility for the deals they introduce into the market and must therefore be in apposition in order to ask sellers of paper, whether exporters or importers, to provide whatever documentation the Primary Forfaiter feels is necessary to on-sell the transaction into the market. In the secondary market, by contrast, documentation is already available and can and should be assessed by more objective criteria, thereby speeding up dealing time and enhancing liquidity.

Recourse

A central issue has revolved around recourse and the "true sale" question. Traditionally, forfaiting operates without recourse to the seller, and this principle is expressly spelt out in Article 3 of the URF. At the same time, there has also been an expectation that, at the very least, Primary Forfaiters would bear responsibility for frauds and defects in documentation that they should have spotted. The URF has tried to steer a middle course through this area by providing:

- for all parties in both primary and secondary markets to be liable if certain basic breaches occur, e.g., a lack of authority of either buyer or seller to sign transaction documentation;

- for recourse to all sellers where the seller was aware of third party rights affecting a transaction, where it fails to transfer all rights and where it does not own the claim being sold;

- for the commercial party who creates the claim, typically the exporter or importer, to be responsible, in addition to the preceding circumstances, where it has breached its obligations under the commercial transaction underpinning the claim;

- for Primary Forfaiters to be liable in circumstances where, essentially, they have failed to use reasonable efforts to ensure the claim being sold is authentic, legal and enforceable.

"True sale"

Whilst details of these provisions are still in flux, they touch also on a critical technical issue: that of achieving a "true sale". This is an accounting issue that is treated somewhat differently under International Financial Reporting Standards (IFRS) and US Generally Accepted Accounting Principles (GAAP). It is clear that an element of recourse to a seller can upset this analysis.

Under IFRS, the essence of achieving a true sale relies on the seller transmitting all risks and rewards to the buyer. However, a distinction must be made between guaranteeing payment by the underlying obligor to a buyer and guaranteeing the existence of a claim that may not be paid for commercial reasons, e.g., insolvency of the obligor.

Nevertheless, fine distinctions can appear, and it is the job of the drafting party to ensure that the analysis falls on the right side of the line.

Future developments

The URF will be accompanied by model form agreements for the primary and secondary markets. These, especially for the primary market, will be important in assuring that the benefits of using the URF are understood. The primary market is commercially much more diffuse and fractured than the secondary, essentially inter-bank, market, and it is here that the URF can have the greatest economic impact. Documentation is just the start.

A nearly final drafting session took place at the IFA Annual conference in Vienna at the beginning of September and further discussions followed in Beijing at the ICC Banking Commission meeting. There is no doubt that the URF has an important vocation in developing a market capable of contributing greatly to the financing of world trade.

Sean Edwards is Head of Legal, Sumitomo Mitsui Banking Corporation Europe Limited and Deputy Chairman of the International Forfaiting Association. His e-mail is [email protected]

 

Unfair trade practices in the PRC

 

DCInsight Vol. 17 No.4 October - December 2011

by Daniel Arthur Laprès and Qin Yang

Trading activity within the People's Republic of China (PRC) is subject to the local regime governing unfair trade practices. Foreign businesses should be aware that even trading activity contracted with PRC parties by entities established outside the PRC could be subject to that regime if the contracts have effects within the PRC. The regulation of activities of enterprises in the public sector, which retains a preponderant role in all economic activity, is important in suppressing these practices.

The PRC Law on Combating Unfair Competition, adopted in 1993, applies to all business operators engaging in the sale of goods or services. In addition, the State Administration for Industry and Commerce (SAIC) has issued regulations expressly prohibiting a wide variety of anti-competitive practices, in particular:

- commercial bribery,

- violations of commercial secrets,

- bid-rigging,

- abuses of commercial names and identities,

- trading abuses by public enterprises and

- abuses or promotions.

Several recent cases serve to remind foreign business people that their nationality does not immunize them against pursuits in the PRC, including under the criminal laws, for their violations of local regulations.

Other competition laws

Freedom of competition is also imposed by stipulations in numerous other laws and regulations.

On 30 August 2007, the National People's Congress adopted the Anti-Monopoly Law, which came into force on 1 August 2008. The law is modeled along the lines of European and American monopoly regulations.

Businesses should also be aware of the Price Law, which is intended to promote fair and open markets while combating price collusion. Prices must be based on production or operating costs and market supply and demand.

In addition, PRC has adopted a Consumer Protection Law that guarantees consumers, inter alia, the right to safety of their persons and property when using products, the right to fair trade terms of trade such as quality warranties, reasonable prices, accurate measures and the availability of recourse in cases of violations of their rights. Advertisers, advertising agents and advertisement publishers are prohibited from engaging in unfair competition.

The Unfair Competition Law

The Unfair Competition Law, mentioned above, prohibits the following acts, amongst others:

- abuses of legal monopolies and abuses of administrative powers,

- use of monopolies by public utility companies to control purchases and sales or to impose upon consumers unreasonable terms with respect to prices or quantities and use of administrative powers to control purchases and sales impairing free circulation of goods in the market,

- infringements of intellectual property and business secrets,

- false or misleading publicity of a product in respect of its quality, its manufacturing components, its use or functions, and

- sales below cost (except for perishable products).

Commercial bribery

Commercial bribery involves giving gifts of property or other means in order to obtain contracts. Property includes cash and material objects paid as fees for promoting sales, publicity, support, scientific research, services, consultation, commissions or reimbursement of expenses to obtain contracts, specifically including the reimbursement of domestic or international travel.

In addition, secret returns of a certain proportion of payments with off-thebooks cash, material objects or other means are considered to be bribery. Acts of bribery committed by employees in the course of their employment are imputed to the employer.

The prosecution currently conducted before the Shanghai courts of an Australian national in connection with the state-owned travel company, GZL, serves as a stark reminder that in these matters prudence is the better part of valour.

Violations of trade secrets

The Trade Secrets Regulations define trade secrets as non-public technical and operational information that the owner has taken steps to keep confidential, that are practical and possess economic value. Obtaining trade secrets by theft, promises of gain, coercion or other illegal means, as well as the disclosure or use of, or permission to use trade secrets acquired by these means are prohibited.

A major danger encountered by some foreign enterprises has arisen from the blurred distinction drawn in PRC law between trade secrets and state secrets. A trade secret may be treated as a state secret when it belongs to a state-owned enterprise. The violations of state secrets attract the most severe sanctions, including criminal prosecution.

A couple of recent cases have highlighted this risk. In July 2010, an American geologist of Chinese origin working for an American consulting company on assignment in China was sentenced by a Chinese court to eight years' imprisonment for attempting to acquire a data base about the petroleum industry, which it claimed was of a commercial nature but which the authorities considered to be a state secret. And in the highly publicized case involving Rio Tinto, the Australian minerals giant, one of its operatives admitted to stealing commercial secrets belonging to CISA, the Chinese Iron and Steel Association, concerning alleged production cuts by a leading Chinese steel maker, state-owned Shougang. While the case was not prosecuted as theft of state secrets, the authorities did invoke state interests to close the debates to the public.

Bid-rigging

The SAIC's measures against bid-rigging deal with tenders in construction projects, purchases of complete sets of equipment, sub-contracts, leases, transfers of land-use rights and leasing of operating locations. Tenders are operations in which bids are invited publicly or through written invitations in accordance with special standards and conditions that are openly disclosed and that culminate in the designation of a winning bidder.

Bid-rigging refers to the use of unfair means by a caller for tenders and a bidder, or amongst bidders, acting in collusion to exclude competitors or harm the interests of the competitors.

Callers for tender may not predetermine the winner of a call for tender, reveal bids of a bidder to others, disclose the floor price to a bidder, assist a bidder in withdrawing or changing its bid or alter its offered price.

Abuses of commercial names and identities

The SAIC deems illegal the use without authorization of an identical or similar name, packaging or decoration specific to a well-known product that misleads purchasers into mistaking the imitation for the well-known product, i.e., products that enjoy a certain reputation in the market. Only names, packaging and decorations not commonly used by similar products are protected. If they are distinctive, the SAIC will protect trade names even when they have not been registered as trademarks.

Trading abuses by public enterprises

Public enterprises are defined as operators of public utilities, including the provision of postal services, telecommunications, transportation, water, electricity, heat and gas and the like. Public enterprises cannot use their market power to impede fair competition, nor can they infringe upon the legal rights and interests of consumers. In particular, public enterprises must refrain from several practices:

- compelling users to buy certain products exclusively from themselves or parties designated by them or limiting their customers' capacity to buy alternative products meeting the required standards;

- compelling users to buy unnecessary products from themselves or persons designated by them; and

- preventing users from purchasing products that meet the required standards, and refusing to sell products or charging excessive prices if users refuse to accept unreasonable conditions.

Abuses of promotions

The SAIC regulations cover sales including incidental articles, money or other economic interests for purchasers, such as lottery-attributed awards for some of the purchasers.

Promotions must include clear representations with respect to the prize, the probability of winning, the number of prizes and, where relevant, their categories, the time and manner of their collection, the time, location and conditions of identification and disclosure of winners, as well as the time and method of informing winners.

Conclusion

For foreign business people, it's important to know that the SAIC plays the dominant role in the investigation and sanctioning of unfair trade practices, subject to the NDRC's jurisdiction over pricing abuses and the Ministry of Commerce's jurisdiction to review enterprise concentrations that might run afoul of the Anti-Monopoly Law. Administrative remedies are often the most effective recourses to combat unfair trade practices.

Civil remedies are also frequently available before the people's courts.

Infractions of the rules against unfair trade practices may also entail criminal pursuits before the people's courts under a general principle of Chinese criminal law that once an infraction of almost any rule has "serious consequences", it may attract criminal sanctions.

Trading with, or otherwise doing business in China, requires that businessmen have a good working knowledge of these laws and regulations.

Daniel Arthur Laprès is an Avocat a la Cour d'Appel de Paris, Barrister and Solicitor Nova Scotia, Canada and Special Counsel to Kunlun Law Firm, Beijing. His e-mail is [email protected]

Qin Yang is a member of the Kunlun Law Firm in Beijing.

 

Financial crisis spawns new L/C players

 

  

Extracts of DCInsight Vol. 17 No.4 October - December 2011

by Mark Ford

In April 2009, world leaders at the G20 summit in London signed off on a package to mobilize a US$250 billion trade finance package to tackle the severe shortage of trade finance caused by the global financial crisis. The package targeted small- and medium-sized enterprises (SMEs) and trade between less-developed countries (LDCs) and countries in the rest of the world that bore the worst brunt of the crisis.

Now, a bevy of multilateral development institutions (MDIs), along with some export credit agencies (ECAs), appear to be bringing substantially more letters of credit to SMEs and LDCs. These comparatively new players in the L/C market also seem poised to support economic rebuilding efforts in the aftermath of revolutions in the Arab world.

Global growth

The G20 package did not involve US$250 billion of new money. It was based on mobilizing that amount of funding over two years. The bulk of the money would come via ECAs and MDIs, both of which have seen their roles change in the last three years.

Whereas ECAs, which are generally state-backed, historically insured export credits extended by banks, the financial crisis triggered a move for them to provide finance directly. Meanwhile, several MDIs sought to specifically boost L/C business by providing full or partial guarantees to confirming banks to cover payment risk on banks in emerging markets. A large proportion of these guarantees have now been applied to L/Cs.

This idea of L/C guarantees predates the last financial crisis. In 1999, the European Bank for Reconstruction and Development (EBRD) launched its Trade Facilitation Programme (TFP) to help nascent market economies grow in Eastern Europe and the Commonwealth of Independent States.

But what is significant for the L/C market today is how similar schemes have burgeoned over the last couple of years and how they are introducing new participants - both banks and businesses - to the L/C market. More than 700 confirming banks throughout the world have now joined the TFP, including 130 banks in 23 of EBRD's countries of operations.

IFC aid

The International Finance Corporation (IFC) introduced its Global Trade Finance Programme (GTFP) to provide guarantees for L/Cs and other trade financing instruments in 2005. As the financial crisis worsened, in March 2008 the IFC said it had issued US$2 billion of cumulative guarantees. Since then, the program has reached new heights. At the beginning of this year, the GTFP passed its milestone US$10 billion mark. In fiscal year ending June 2011 (FY11) it issued a total of US$4.6 billion worth of guarantees, an increase of US$1.2 billion over the previous fiscal year.

The program has now provided more than 3,000 trade finance guarantees on behalf of issuing banks, and the IFC's focus is clearly on SMEs in the developing world. IFC executive vice president and CEO, Lars Thunell, says the "guarantees have allowed banks to increase their support to small- and mid-sized firms and enabled trade that otherwise would not have happened, especially in the poorest countries."

Nearly 80 per cent of the GTFP's FY11 support went to SMEs, while support for trade in the poorest countries was worth US$2.4 billion - 40 per cent more than in the same period in the previous year.

In the same financial year, the volume of guarantees provided by the GTFP to sub-Saharan Africa grew to US$931 million in 25 countries, all but one of which rank amongst the world's 79 poorest countries. Latin America was the dominant region during the fiscal year, representing 31 per cent the program's business. In the Middle East and North Africa, the IFC guaranteed more than 40 per cent more global guarantees and commitments than in the previous year, while guarantees for the West Bank and Gaza increased by 70 per cent. The GTFP has also grown in central and southern Europe and in Asian LDCs, including Bangladesh and Nepal.

While the IFC's achievements are impressive, its GTFP is not universally acclaimed. In a recent survey of trade finance by the African Development Bank (AfDB), some commercial banks said they found the IFC useful, but somewhat expensive and slow to respond.

Amongst the 74 African banks surveyed, several indicated that the lack of IFC support for public sector transactions was a constraint. Smaller and newer banks said they lacked the track record and balance sheet size to work with IFC. Some respondents, many of which the AfDB said are participants in the GTFP, noted that there is client interest in certain countries where the IFC does not operate.

But for others, the program seems to have made a significant difference. One Ghanaian banker says that one of her clients, a power producer, was only able to import the electrical equipment it needed after the IFC guaranteed an L/C for the client.

Other schemes

Other MDIs operating broadly similar L/C guarantee schemes include the AfDB and the Asian Development Bank (ADB). Recognizing the similarities, the AfDB - which introduced its TFP some years after ADB did - is to adopt and share with ADB all legal document templates, operation manuals and information technology. ADB and AfDB expect cooperation to grow in the future, which may augur some consolidation of the various MDIs' L/C guarantee activities.

ADB's programme has also expanded rapidly over the last year or so and provided support for US$2.8 billion worth of trade in 2010, up a substantial 47 per cent from 2009. The AfDB's Trade Finance Initiative (TFI) was only announced in 2009 and aims to provide up to US$1 billion of support to African commercial banks and other financial institutions to reinvigorate their trade finance operations.

Arabian challenges

Now the AfDB has a new focus. In July, it said that it and the World Bank would each provide a US$50 million line of credit in support of Tunisian SMEs to help mitigate the post-revolution funding challenges in the aftermath of the overthrow of former President Zine el-Abidine Ben Ali. The Tunisian Central Bank will finance the SMEs through financial institutions.

The Islamic Development Bank (IDB) will step in to facilitate L/C transactions and provide a range of other trade finance facilities to help Libya under its Transitional National Council (TNC). Libya is the bank's second largest shareholder and could benefit from the Documentary Credit Insurance Policy (DCIP) available from IDB subsidiary, the Islamic Corporation for the Insurance of Export Credit and Investment (ICIEC).

Under the DCIP, the ICIEC guarantees L/C confirmations by foreign banks. Cover is broadly available for many transactions, including for LDCs where banks would not normally confirm L/Cs without the ICIEC's support. Libya owns 9.47 per cent of the IDB; the only larger shareholder is Saudi Arabia with a 23.61 per cent stake.

Concerns have been expressed throughout the crisis by the TNC and Libya's Central Bank that mechanisms should be in place so that L/Cs can enable oil exports as soon as possible. These institutions will no doubt want to co-opt whatever assistance is available to ensure that smooth L/C flows become part of the country's commercial landscape.

Mark Ford's e-mail is [email protected]

 

A brief history of 'Partial drawings and shipments'

By Gary Collyer

In this first of a new series of newsletters we look at the origins and development of the wording of certain UCP articles, and where certain ICC Banking Commission Opinions refer to, and reinforce, the current wording. In this newsletter we look at UCP 600 article 31 - Partial Drawings or Shipments.

In the first UCP, published in 1933, the sub-heading to article 36 was 'Partial Shipments'. It was not until reference to standby letters of credit was incorporated into article 1 of UCP 400 (1983 Revision) that the sub-heading changed to "Partial drawings and/or shipments". 

1933 Revision – "Uniform Customs and Practice for Commercial Documentary Credits Publication No. 82" 

Partial Shipments

Article 36

Banks may refuse to pay for partial shipments if they think it advisable. 


In May 1938, the USA Commission on Foreign Banking adopted UCP 82 but issued a number of guidelines to the rules including an exception to article 36. This exception stated that documents covering a partial shipment were acceptable unless expressly prohibited by the credit. It was also stated that even if the credit mentioned the name of a steamer (vessel), partial shipment or shipments by that steamer (vessel) were acceptable.

It should be noted that the concept adopted by the Commission on Foreign Banking, of partial shipments being accepted unless expressly prohibited, forms the basis of article 31 today. This guideline then formed the basis for the wording that appeared in the revision of UCP 82, i.e., UCP 151 (article 36).

It would be very interesting to see how the rule in UCP 82 article 36 would be applied if the wording were the same in UCP 600!! 

It was not until UCP 400 sub-article 44 (c) that reference was first made to the effect of partial shipments involving dispatch by post. It was UCP 500 sub-article 40 (c) that expanded this rule to also cover dispatch by courier. 



2007 Revision – "Uniform Customs and Practice for Documentary Credits Publication No. 600"

Partial Drawings or Shipments 

Article 31 

a. Partial drawings or shipments are allowed.
 

b. A presentation consisting of more than one set of transport documents evidencing shipment commencing on the same means of conveyance and for the same journey, provided they indicate the same destination, will not be regarded as covering a partial shipment, even if they indicate different dates of shipment or different ports of loading, places of taking in charge or dispatch. If the presentation consists of more than one set of transport documents, the latest date of shipment as evidenced on any of the sets of transport documents will be regarded as the date of shipment.
 
A presentation consisting of one or more sets of transport documents evidencing shipment on more than one means of conveyance within the same mode of transport will be regarded as covering a partial shipment, even if the means of conveyance leave on the same day for the same destination. 

c. A presentation consisting of more than one courier receipt, post receipt or certificate of posting will not be regarded as a partial shipment if the courier receipts, post receipts or certificates of posting appear to have been stamped or signed by the same courier or postal service at the same place and date and for the same destination. 



There is often confusion in understanding the meaning of "means of conveyance" and "mode of transport" as referred to in UCP 600 sub-article 31 (b). ICC Opinion R240 offered a definition of each term whilst responding to the following request for an interpretation of UCP 500 sub-article 40 (b): 

"The issue is whether the term 'means of conveyance' as used in UCP 500 sub-article 40 (b) has a meaning which in substance is different from the meaning of the term 'mode of transport' as used in UCP 400 sub-article 44 (d)." 

In the analysis of the referenced opinion, it was stated: 

"The term 'means of conveyance' has the meaning of a single vehicle (e.g. vessel, aircraft, truck) whereas the term 'mode of transport' means the type/nature of the transport (e.g. transport by sea, transport by air, transport by road). 

That both terms are not synonymous is evident from the context in which they are used in a number of provisions, i.e. in UCP 400 [e.g. sub-article 25(c), article 28, sub-article 29(a), sub-articles 44 (b) and (d), UCP 500 (e.g. sub-article 26(a), sub-articles 28(c) and (d), sub-article 40(b), Incoterms 1990 (various places)]." 

Under UCP 600, sub-article 19 (b) also includes both terms and outlines the different context in which they are used: 

"For the purpose of this article, transhipment means unloading from one means of conveyance and reloading to another means of conveyance (whether or not in different modes of transport) during the carriage from the place of dispatch, taking in charge or shipment to the place of final destination stated in the credit." (emphasis added) 

Opinion R240 also responded to a common enquiry made to the ICC Banking Commission: 

"Suppose that the transport documents (two separate CMRs) indicate that shipment has/shipments have been made on two separate trucks but for the same journey and to the same destination. The documents further indicate the same date and place of taking in charge. 

Question: Have partial shipments been effected or not?". 

The analysis and conclusion given by the ICC Banking Commission stated that two separate trucks are not the same means of conveyance. Therefore, the use of two trucks is to be regarded as a partial shipment. The second paragraph of UCP 600 sub-article 31 (b) reflects this position. 

In ICC Opinion R478 a question was asked as to whether, under a L/C that prohibits partial shipment, it is correct to accept a drawing evidencing shipment by one truck with a trailer? 

The analysis and conclusion given by the ICC Banking Commission stated that dispatch by a truck with a trailer does not constitute a partial shipment. The truck and trailer are considered to be one means of conveyance. 

ICC Banking Commission Opinion R369 focusses upon a shipment made by rail, consisting of 3 wagons each containing 60 tonnes of wheat flour. The initiator described the shipment as being "in one and the same day, in one and the same direction, in one and the same place by one and the same train." 

A bank refused the documents based upon ICC Opinion 470/GE46 which included the following : "... separate trucks are not the same means of conveyance …". "The term "means of conveyance" has the meaning of a single vehicle (e.g. vessel, aircraft, truck … )." 

The bank was clearly attempting to apply the principle outlined above, of separate trucks indicating a partial shipment event, to a shipment made by rail when more than one wagon is used, but they are part of the same train. 

The analysis and conclusion given to this opinion included "the use of a train with wagons attached, is a different set of circumstances to that in query 470.GE.46. Here we have one train with three (or more) wagons attached. On this basis, transport documents which evidence that the wagons were attached to the same train for the same journey would not constitute a partial shipment, as they are part of the same means of conveyance." 

The principle of "A presentation consisting of more than one set of transport documents evidencing shipment commencing on the same means of conveyance and for the same journey, provided they indicate the same destination, will not be regarded as covering a partial shipment, even if they indicate different dates of shipment or different ports of loading, places of taking in charge or dispatch" (as stated in UCP 600 sub-article 31 (b)) is generally well understood. 

If a credit prohibits partial shipment, the beneficiary may present one or more sets of transport documents always provided the transport documents indicate the same destination and otherwise comply with the content of sub-article 31 (b). 

ICC Opinions R368 and 370 refer to situations where the intention of the applicant or beneficiary is for the goods to be offloaded at more than one port of discharge. In these circumstances, the credit must clearly indicate these ports of discharge, or that discharge may be made at one or more ports within a given range or geographical area. A credit so worded will modify the effect of the reference to 'same destination' in sub-article 31 (b). 

Confusion can often occur when a credit contains a shipment schedule and there is no further reference made to partial shipments. ICC Opinion R690 covers one such example. The credit stated in field 43P "allowed see under Field 47A". Field 47A gave details of a shipment schedule indicating the need for a certain quantity of goods to be shipped no later than certain specified dates. These dates were latest shipment dates as opposed to shipment requirements falling within given periods. The result of this (poor) construction was that the beneficiary could ship any quantity of goods, subject to complying with the minimum quantity to be shipped by each respective date. The credit did not prohibit partial shipments within each stated latest shipment date. The issuing bank refused the documents on the basis that the beneficiary had made a number of shipments within the latest shipment date stated for the first quantity. 

The conclusion given by the ICC Banking Commission referred to the fact that there was no reference in the credit that each item in the shipment schedule was to be shipped in one lot. If the intention, where the credit contains a shipment schedule, is for no partial shipment to be effected within each period then the credit must so state. 

The condition, partial shipments, is often seen as a simple decision of stating 'allowed' or 'not allowed'. In most cases, it is as simple as that. However, when the credit includes conditions relating to the shipment and, possibly, a shipment schedule, care should be taken to ensure that the credit fully reflects the requirements of the applicant as to the basis and number of shipments that are to be made. 

--------------------------------------------------------------

Drafts: the date of issue in bills of exchange 

DCInsight Vol. 17 No.3 July - September 2011

by Wangxuehui (English name Ofei)

In DOCDEX Decision No. 260, the L/C was available with any bank by negotiation at sight. The Initiator (negotiating bank) negotiated documents presented under the L/C and sought reimbursement at sight, as the documents were found to be in compliance with the terms and conditions of the L/C. The Respondent refused to take up the documents, stating that one of the discrepancies was "Draft not dated". The Panel of Experts' analysis cited paragraph 13 of ISBP 645 (dealing with UCP 500) to read: "Drafts, transport documents and insurance documents must be dated even if a credit does not expressly so require." But it then concluded that: "In our view, the date of a draft is only required in specific circumstances for determining the maturity date of the draft, e.g., if drawn 'at sixty days date' ... This would never be the case for a draft drawn 'at sight' [emphasis added]." In my view, this Decision misunderstands the role of the date of issue for drafts. Moreover, it conflicts with ISBP 645 paragraph 13 as well as with ISBP 681 paragraph 13.

Mandatory items

A bill of exchange is not only a means of payment, but also means of finance in both domestic and foreign financial markets. Therefore, many countries set up their own instruments act to standardize the use of drafts, promissory notes and cheques. Among these, the Bill of Exchange Act, 1882 and Convention Providing a Uniform Law For Bills of Exchange and Promissory Notes (Geneva 1930, abbreviated hereafter as the Geneva Convention 1930) are the most important, since they influence other countries' laws or acts.

Consider first the Geneva Convention 1930. Article 1 stipulates that a bill of exchange contains "A statement of the date and of the place where the bill is issued". Article 2 further emphasizes that "An instrument in which any of the requirements mentioned in the preceding Article is wanting is invalid as a bill of exchange, except in the cases specified in the following paragraphs ... ." The exceptions do not include the date of issue.

Obviously, the date of issue is mandatory to constitute a valid draft.

The Bill of Exchange Act, 1882 has no similar provision; however, it does have a requirement in this respect. Paragraph 3(4) ("Bill of exchange defined") of Part II stipulates that a bill of exchange is not invalid if it is not dated. This is a different position from that in the Geneva Convention. But article 12 ("Omission of date in bill payable after date") stipulates: "Where a bill expressed to be payable at a fixed period after date is issued undated, or where the acceptance of a bill payable at a fixed period after sight is undated, any holder may insert therein the true date of issue or acceptance, and the bill shall be payable accordingly."

In this Act, then, the date of issue is not mandatory, but any holder may insert the date of issue or acceptance if the draft is not dated. This position is different from DOCDEX Decision No. 260, which states that a draft need not be dated.

The Negotiable Instruments Law of The People's Republic of China (2004 revision) is similar to the Geneva Convention 1930. Article 22 of this law states that a draft shall bear a number of items, one of which is the date of the draft. It also indicates that a draft lacking any one of the items listed is invalid.

The fact that some Acts state that the date of issue in a bill of exchange is mandatory, while others do not, inevitably leads to disputes in practice.

Role of date of issue

In fact, the importance of the date of issue is that it can decide the deadline for presentment for acceptance or payment, which is key to a bill of exchange. This is reflected in articles 23 1 and 34 2 of the Geneva Convention 1930.

Paragraph 45 ("Rules as to presentment for payment") of the Bill of Exchange Act, 1882 states: "Subject to the provisions of this Act, a bill must be duly presented for payment. If it be not so presented the drawer and indorsers shall be discharged." Its sub-clause (2) states: "Where the bill is payable on demand, then, subject to the provisions of this Act, presentment must be made within a reasonable time after its issue in order to render the drawer liable, and within a reasonable time after its indorsement, in order to render the indorser liable. In determining what is a reasonable time within the meaning of this section, regard shall be had to the nature of the bill, the usage of trade with respect to similar bills, and the facts of the particular case." This may be difficult to apply in practice, because the term "reasonable time" can be ambiguous.

Paragraph 1 of Article 17 in the Negotiable Instruments Law of The People's Republic of China stipulates: "The rights to the negotiable instruments shall expire if not exercised within the following time limits: within two years from the time of the maturity of the negotiable instruments for the right of the holder to the drawer and acceptor, or, within two years from the date of draft for bills and notes payable at sight." Moreover, Article 55 states :"A holder of a draft shall make presentation for payment according to the following time limits: 1. Presentation for payment shall be made to the payer within one month starting from the date of draft for a draft payable at sight ... ".

Even though there are different opinions concerning this question, it remains the case that the date of issue is important in determining the time limit for presentment. The Decision in DOCDEX No. 260, however, talks about the date of issue as determining the date of maturity. This is difficult to understand.

ISBP 645 and ISBP 681

The two versions (No. 645 and No. 681) of ISBP both emphasize in paragraph 13: "Drafts, transport documents and insurance documents must be dated even if a credit does not expressly so require [emphasis added]". There is no language in ISBP indicating that that a draft may not be dated. ISBP is not a law but is a set of guidelines used widely by banking practitioners when checking documents under an L/C. But since ISBP makes clear that the date must be shown in drafts, it seems odd that DOCDEX Decision No. 260 drew the conclusion that a draft payable at sight need not be dated.

Conclusion

From the above analysis, it is clear that even for drafts payable at sight, the date of issue is required. Though the Bill of Exchange Act, 1882 takes a different view, it nonetheless stresses that for a draft payable on demand, the presentment for payment must be made within a reasonable time after its issue. This implies the importance of including a date of issue in a bill of exchange.

Wangxuehui (English name Ofei) is a Lecturer in the School of Economics and Management at Anhui Agricultural University in Hefei, Anhui, China. Her e-mail is [email protected]

1 "Bills of exchange payable at a fixed period after sight must be presented for acceptance within one year of their date. The drawer may abridge or extend this period. These periods may be abridged by the endorsers."

2 "A bill of exchange at sight is payable on presentment. It must be presented for payment within a year of its date. The drawer may abridge or extend this period. These periods may be abridged by the endorsers. The drawer may prescribe that a bill of exchange payable at sight must not be presented for payment before a named date. In this case, the period for presentation begins from the said date. "

 

The dangers for trade finance under Basel III

Trade finance is an essential facility for world trade. But the safe, short-term and self-liquidating character of trade finance needs to be better recognized under the current Basel II and III frameworks.

 At last, evidence is now available to demonstrate that trade finance is one of the safest areas of international banking. Hence, it needs to maintain its status under international regulation.

There was a time when trade finance received favourable regulatory treatment. It was viewed as one of the safest, most collateralized, and self-liquidating forms of finance - although no systematic data was available to demonstrate it. This view was reflected in the capitalization for cross-border trade credit in the form of letters of credit and similar securitized instruments under the Basel I regulatory framework, put in place in the late 1980s and early 1990s. The Basel I text states that "Short- Term self-liquidating traderelated contingencies (such as documentary credits collateralised by the underlying shipments)" would be subject to a credit conversion factor equal or superior to 20% under the standard approach.

This meant that for unrated trade credit of US$1,000,000 to a corporation carrying a normal risk weight of 100 per cent, and hence a capital requirement of 8 per cent, the application of a credit conversion factor of 20 per cent would "cost" the bank US$16,000 in capital.

The basic text and credit conversion factor (CCF) value for trade finance was kept largely unchanged under Basel II. But issues of pro-cyclicality, maturity structure and credit risk later arose. In an internal rating-based and risk-weighted assets system, the amount of capitalization to backup lending depends on the estimated risk at a particular point in time and for a particular borrower. For financial institutions without the resources to operate their own models of credit risk estimation, the standardized approach provides guidelines of how to manage risk and allocate capital according to the wider proposed set of economic risk categories.

Benchmarks and ratings

External credit ratings for cross-border lending under Basel II are based on benchmarks provided by international commercial ratings agencies. More sophisticated financial institutions rely on an "advanced internal rating-based" approach to estimate the credit risk, taking into account a number of compulsory criteria. Among the most contested of these is that, under Basel II, the country risk cannot be worse than any counterparty risk in that country - therefore, any deterioration of the country risk during a recession (like the recent one) will automatically and negatively affect the country risk regardless of the underlying creditworthiness of that counterparty.

It is alleged by bankers that trade-related lending is disadvantaged in low cycles because of the high concentration of lending on small and medium-sized enterprises and because of the de facto one-year maturity floor applied to trade credits (while most of this credit revolves every 90 to 180 days).

As noted by ICC in 2009, "the capital intensity of lending to mid-market companies under Basel II is four to five times higher than for equivalent transactions under Basel I." To alleviate some of the biases of Basel II concerning trade finance, a sentence made its way into the communiqué of the G-20 Leaders in London in April 2009, inviting regulators to exercise some flexibility in the application of these rules in support of trade finance. That has not been the case yet, and remains an issue for the G-20 to consider.

Regulators

Generally, regulators temper the professionals' concerns with the following arguments: first, they say the 20 per cent CCF recognizes that trade credits are normally less risky than ordinary loans if secured. Second, acknowledging that the bulk of the trade finance business is in the hands of large international banks, the regulators also suggest that, under the advanced internal ratings-based approach, these institutions can determine their own estimates of the appropriate CCF to apply to a trade finance commitment when calculating the required amount of capital to back it up.

Finally, perhaps the most difficult issue facing trade financiers is the maturity cycle applied to the regulation of short-term trade lending. Countries have the option to waive the one-year maturity floor on the capitalization of trade finance commitments, but to date only the UK, Germany and Hong Kong's regulators have done so.

Basel III proposals

Notwithstanding the treatment of trade finance in Basel II, trade finance may be facing another hurdle under the newly adopted package of regulatory measures, commonly called Basel III. One of the key measures in this package aims to reduce systemic risk by supplementing enhanced risk-based capital requirements with a leverage ratio - hence reducing incentives for "leveraging". Reducing these incentives is an objective generally shared by the community of international organizations, be they responsible for finance, macroeconomics or trade. The "leverage" ratio would apply above a certain threshold of capital in the form of a flat 100 per cent CCF to certain off-balance-sheet items, though it is alleged that the ratio is not risk-based. The issue for the trading community is that this would include "unconditionally cancellable commitments, direct credit substitutes, acceptances, standby letters of credit, trade letters of credit, failed transactions and unsettled securities".

This provision is fuelling fears in the trade finance industry. While capital-wise, the in-balance-sheet treatment of trade credit seems not to have changed, many trade financiers believe the proposed CCF for off-balance-sheet operations will result in a five-fold increase relative to the 20 per cent credit conversion factor used under Basel II for stand-by letters of credit and similar trade bills - as well as for other any other kind of off-balance-sheet assets.

Misunderstandings

While there is logic in tightening the treatment of some toxic off-balance-sheet financial instruments, there was clearly a misunderstanding regarding the application of stricter regulation to letters of credit and similar trade bills. It is based on the fact that there is no evidence historically - or recently - that these exposures have ever been used as "a source of leverage", given that they are supported by an underlying transaction that involves either movement of goods or the provision of a service.

The question of why off-balance-sheet trade exposures are not being automatically incorporated into the balance-sheet (to avoid the leverage ratio) is one of process. The processing of letters of credit, which are highly documented for the financial transactions' own security, involves off-balance-sheet treatment, at least until such time as the verification of the documentation is finalized - a process that has existed a long time. The financial crisis has even resulted in greater scrutiny of such documentation.

The rigour of the process of document verification is at the very heart of what a letter of credit is, and testifies to its safety. Given the high rejection rate of poorly documented letters of credit (up to 75 per cent for first submissions), and the fact that, if definitively rejected, the letter of credit might not even enter the balance-sheet, it is argued that the off-balance-sheet management of these exposures is necessary and, in most cases, only a temporary treatment of what will eventually become an on-balance-sheet commitment.

The perceived five-fold increase in capital requirements for off-balance-sheet letters of credit would increase the costs of banks that offer these risk-mitigation products. Either these costs will be passed on to customers, hence making even more difficult to smaller businesses to trade internationally, or, in the absence of incentives to issue letters of credit, customers may simply choose to use onbalance- sheet products such as overdrafts to import goods. The latter carry less stringent documentary requirements and are potentially far riskier for the banking sector in general.

Finally, the issue has great importance for developing countries' trade. Unlike in developed countries, open account financing is neither appreciated by, nor necessarily accessible to, many developing countries. Traditional letters of credit bring more security and are more widely used. Given that world trade is likely to be driven by South-South trade in the future, the prudential treatment (and reasonable cost) of letters of credit is critical for developing and emerging market economies.

Conclusion

The G-20 in Seoul, while adopting the Basel III package, asked the Basel Committee to "evaluate the unintended consequences" of some of the measures described above. A presentation of this evaluation is expected in the autumn of 2011, before the next G-20 Summit in Cannes. While the Committee does not intend to reduce the attractiveness of secured trade finance instruments, financial regulation is inherently complex and requires the understanding of all sides.

In issues that are at the crossroads of trade and financial regulation, there needs to be a thorough examination of both cultures and instruments. Prior to the Basel Committee's evaluation of these "unintended consequences", the trade finance community has worked hard to provide solid evidence that trade finance is one of the safest propositions in finance.

With the encouragement of WTO's Expert Group on Trade Finance, the world's leading banks have decided, in tandem with the Asian Development Bank and ICC, to establish a loss default registry on trade finance. Initial results have indicated that, in the past five years, out of a total of transactions worth US$2.5 trillion, the default rate on trade finance transactions was only 0.2 per cent (complete results can be found on the ICC's website, www.iccwbo.org under "Banking Technique and Practice"). These results have been presented to the Basel Committee.

ICC has committed to expand the registry by increasing the number of participating banks and making comprehensive information accessible to international regulators. This initiative will increase the understanding between the regulatory and trade communities and will help demonstrate that the trade finance community provides a cautious and sustainable model of banking that has financed the expansion of international trade without major hurdles up to and including the recent crisis. Banks wishing to provide information to the registry should contact Thierry Senechal at ICC, e-mail: [email protected]

The trade and regulatory communities should continue their dialogue with the aim of encouraging regulators to devise prudential rules on trade finance that are both balanced and fair.

Marc Auboin is Economic Councellor at the World Trade Organization (WTO). This article represents his own views and not necessarily those of WTO.

The end of the Bill of Lading as we know it?

 

  
 

Introductory note

As may be known, work on the text of a Draft International Convention on Contracts for the Carriage of Goods Wholly or Partly by Sea has recently been completed by an UNCITRAL Working Group, which had been working on a draft legal instrument since 20021. The completed draft text is now subject to consultations by Governments with their industries, before being submitted for adoption by the UNCITRAL Commission in June/July 2008, and the UN General Assembly later this year.

The draft Convention is to provide a modern successor to the Hague-Visby and Hamburg Rules, the two main international liability regimes governing carriage of goods by sea but it would also govern contracts for multimodal transportation that involve an international sea-leg. The draft Convention consists of 98 articles which are contained in 18 chapters. To a large extent, the draft Convention covers matters, which are dealt with in existing liability regimes, namely the Hague-Visby Rules and the Hamburg Rules, albeit with significant changes in terms of structure, wording and substance. In addition, several chapters are devoted to matters currently not subject to international uniform law, such as delivery, the transfer of the right of control and of rights of suit. The draft Convention also provides for electronic communication and the issue of electronic substitutes to traditional paper documents, largely by recognizing contractual agreements in this respect and by according electronic records similar status as paper-based documents. While detailed consideration of the draft Convention's individual provisions or even a summary of its content is not possible here, this note concentrates on one particular set of provisions which, among others, is controversial and potentially problematic: the carrier's delivery obligation in cases where goods are shipped under a negotiable bill of lading, but the consignee fails to claim delivery when the vessel arrives at destination. It is submitted that the provisions, if adopted, may seriously undermine the document of title function of the negotiable bill of lading, which is key to its use in international trade.

Before focusing on what is being proposed, it is appropriate to first recall the context in which negotiable bills of lading are used, as well as their special features, advantages and disadvantages.

What makes negotiable bills of lading special?

As is well known, the negotiable bill of lading has traditionally played a key role in international trade, as it fulfils a number of functions facilitating trading in an international environment. It operates as a receipt providing evidence that goods conforming to the contract have been shipped as agreed and are in the physical possession of the carrier for delivery to the consignee at destination. The bill of lading also contains or evidences the terms of contract with the carrier. Both of these functions are important in the performance of international sales contracts and in the context of a potential cargo claim against a carrier. Most importantly, however, the negotiable bill of lading operates as a transferable document of title, and it is this aspect, which sets the document apart from alternative transport documents, such as non-negotiable seawaybills2. A document of title, as traditionally understood in English common law3, is a document, which provides its holder with the exclusive right to demand delivery of the goods covered by it. As the goods will only be released to the consignee against surrender of the document, possession of the document amounts to constructive possession of the goods. If the document is so-called "negotiable", i.e. is made out "to order", or to the order of a named party, or is a bearer document, the right embodied in the document can be transferred along a chain of sale contracts by delivery, with any necessary endorsement, of the document alone4. Thus, while goods are in the physical possession of a carrier during transit, a seller is able to pass possession and property in the goods to a subsequent buyer simply by passing on the negotiable document of title, i.e. the negotiable bill of lading5. By the same token, the document can be pledged to a bank and thus may be used as a security to raise finance.

The use of a negotiable bill of lading provides clear advantages, if sale of goods in transit is envisaged and/or if documentary security is required by banks, buyers or sellers involved in an international sale or its financing. As, however, the document needs to be physically transferred to the final consignee, possibly along a chain of buyers and banks, a number of problems may be associated with the use of negotiable bills of lading. These include high administrative costs related to the issue, processing and transfer of paper documentation and the problem of delayed arrival of the document at the port of discharge, in particular where travel times are fast, e.g. in short-sea shipping.

While in practice, a carrier may frequently agree to release the goods against a letter of indemnity, if the bill of lading is delayed, this is not unproblematic. If the lawful consignee who later obtains the bill of lading takes delivery under a letter of indemnity, no harm is done and there will be no-one to complain. However, if the goods are released without the bill of lading to either a consignee unwilling or unable to pay his seller or bank, or to the wrong consignee, such practice may compromise the position of an unpaid seller or bank, or a consignee out of pocket and may expose the carrier to a claim for misdelivery. Letters of indemnity offer good protection to carriers in cases where the issuer is solvent and reliable, but may not in all cases be enforceable. Against this background, there is general agreement that negotiable bills of lading should only be used in cases where a document of title is required, i.e. where sale of goods in transit is envisaged or where independent documentary security is required by buyers, banks or sellers.

The successful development of an electronic alternative to the negotiable bill of lading would potentially avoid these problems to a large extent. At the same time, any efforts in this direction are made more difficult by the need for (a) secure "electronic replication" of the unique document of title function and (b) full legal equivalency of any electronic alternatives. While renewed efforts to come up with a commercially viable electronic alternative to the negotiable bill of lading appear to be underway6, no such electronic alternative is yet in commercial use.

Can bill of lading clauses convert a negotiable bill of lading into something other than a document of title?

Carriers clearly don't like the situation and some are looking for solutions that would allow them to lawfully dispose of the goods without delay, once a vessel arrives at its destination. As a result, certain clauses have appeared, in some liner bills of lading, over recent years, which seek to protect the carrier, by stating that surrender of the document is not required to obtain delivery, but shall be "at the carrier's option". Clearly, the aim of this type of provision is for liner companies to avoid as far as is possible any adverse effects which may arise from delayed arrival of the documents at destination. However, the approach taken gives rise to concern and is likely to lead to much litigation. Whether courts will give effect to clauses of this type is far from clear, in particular as they are highly unusual, effectively seeking to convert a document, made out "to order" and bearing the title "negotiable", into a document which is not a document of title and thus has little in common with a negotiable bill of lading.

If these types of clauses were to be held effective, the relevant documents, effectively deprived of their document of title function, may not be considered good tender under a documentary sale on shipment terms. Clearly, a document which is no document of title would not normally be suited to sale of goods in transit along a chain of CIF buyers. Why would a buyer who has no established relation of trust with a seller in a different jurisdiction pay against a document which, rather than providing him with "constructive possession of the goods" or "the key to the warehouse", is no more than a piece of paper, without any certainty that he will eventually obtain the goods or a compensatory right to claim damages in case of misdelivery? Also, it is not clear whether such a document would be acceptable under a letter of credit which requires tender of a bill of lading. While the ICC Banking Commission appears, so far, not to have expressed any firm views on this question, it would not seem to be in banks' interest to accept tender of bills of lading, which may not qualify as documents of title: in some instances, a bank might need to be able to realize the security that is inherent in a negotiable document of title.

Negotiable bills of lading and delivery of goods under the draft Convention

Chapter 9 of the draft Convention is devoted to "Delivery of the Goods" and sets out the parties' respective rights and obligations. Art. 45 of the draft Convention introduces an express obligation on the part of "a consignee that exercises its rights under the contract" to "accept delivery of the goods" at the time and location agreed in the contract or, failing such agreement, at the time and location at which delivery could reasonably be expected "according the terms of the contract, the customs, practices and usages of the trade and the circumstances of carriage". Art. 46 requires the consignee to acknowledge receipt of the goods and Articles 47-49 provide specific rules regarding delivery of the goods depending on the type of transport document or electronic record issued. Of particular interest in the context of negotiable bills of lading is Article 49, which sets out the relevant rules on delivery when a negotiable transport document or electronic record has been issued, as well as Article 50, which sets out extensive rights of the carrier in cases where goods remain undelivered.

The relevant provisions contained in Art. 49 are complex and have to be considered in context with a number of different provisions elsewhere in the draft Convention. However, their effect appears to be as follows7:

- The "holder" of a negotiable transport document8 is entitled to claim delivery of the goods, after they have arrived at the place of destination, against surrender of the document and, in the case of an order document, properly identifying itself (i.e. as shipper, consignee or endorsee)9. The carrier shall refuse delivery, unless these conditions are met10.

- However, in cases where the vessel arrives and the "holder" does not claim delivery, the carrier is entitled to seek alternative delivery instructions. This covers the situation where a consignee (a) holds the bill of lading but is not there to take delivery of the goods in accordance with Art. 45, or (b) is not in possession of the bill of lading and thus does not qualify as "holder"11.

- In these situations, a carrier would be entitled to deliver the goods according to instructions from the "controlling party", that is to say the "holder", i.e. an endorsee in possession of the document and, if that party cannot be located, the original shipper12. Especially in scenario (b), above, where the bill of lading may still be held by someone up a chain of contracts, it would seem likely that the "controlling party"/"holder" may often not be easy to locate and the carrier would proceed to seek instructions from the original shipper.

- In cases where the original shipper, "after reasonable effort" cannot be found, the carrier would approach the so-called "documentary shipper" for delivery instructions, i.e. a party who is not the contracting shipper, but "accepts to be named as shipper in the transport document"13, such as an F.O.B. seller.

- If the carrier delivers the goods upon such instructions, he is discharged from its contractual delivery obligation14.

- A consignee who subsequently obtains the negotiable transport document "acquires rights against the carrier under the contract of carriage, other than the right to claim delivery of the goods"15. While not expressly stated, it follows that the consignee also loses the right to claim damages for misdelivery16.

- There is a proviso which appears to safeguard the right to claim delivery of "a holder that becomes holder after such delivery", i.e. a consignee who obtains the bill of lading after goods have arrived, but who, at that time, "did not have and could not reasonably have had knowledge of such delivery" to a third party17.

- However, this apparent protection is lost, if the transport document states18 "the expected time of arrival of the goods, or indicate[s] how to obtain information as to whether the goods have been delivered". In these cases, it is presumed that "the holder at the time it became a holder had or could reasonably have had knowledge of the delivery of the goods".

- Thus, it seems that the consignee loses any right to claim damages for misdelivery if the transport document indicates the vessel's ETA or indicates how to find out if goods have been delivered to someone else. It can be assumed that in future practice relevant wording would be included, as a matter of course, in transport documents.

What are the practical implications?

The rather astonishing net upshot of what is being proposed is as follows: in cases where the final consignee/endorsee of goods shipped under a negotiable bill of lading, typically a CIF buyer in a chain of contracts, is notified of the arrival of the goods at destination but (a) is late in requesting delivery of the goods from the carrier, for whatever reason, or (b) is not yet in possession of the bill of lading, the consignee may be left empty-handed and not be able to sue the carrier for misdelivery. This, despite the fact that the consignee, the final CIF buyer, would have had to accept the bill of lading as good tender under a documentary sale contract and will have paid the purchase price. The established law of international sales on shipment terms, as it stands, would not seem to entitle the buyer to reject such a bill of lading against his CIF seller or offer any subsequent redress to the buyer/consignee. Whether such a "loss" would be covered by any existing cargo insurance, even under Institute Cargo Clause A, is, at the very least doubtful; in any event, insurers would not seem to be able to seek redress from the carrier, who would appear to be protected by the provisions of the draft Convention in any subrogated claim for misdelivery.

The provisions seek to shift the risk of delayed bills of lading from carrier to consignee. The statutory solution that is being proposed resembles, in its aims, the controversial emerging practice among some liner carriers, mentioned above, who by way of including suitable clauses in their standard transport documents, seek to make surrender of the negotiable bill of lading optional rather than required. It differs, however, in a number of central respects. First, as mentioned above, it is not yet clear whether courts would give effect to relevant bill of lading clauses. However, courts would have to give effect to the statutory solution proposed in Art, 49, if the provision stays in the final draft text of the Convention and provided the Convention enters into force. Secondly, while the abovementioned clauses are still rather the exception than the rule, and are not used by some of the largest liner operators, "genuine" negotiable bills of lading are still available to traders who require a document of title, either for the purposes of sale of goods in transit, or as independent documentary security. The question of whether documents bearing relevant clauses would be acceptable under CIF contracts or indeed letters of credit has not yet been tested in the courts or even been subject to thorough academic debate. In contrast, if and when Art. 49 becomes effective, the situation seems to be rather clear cut: even where traders - or their banks - may require a document of title and proceed on the assumption that a negotiable bill of lading will serve their purpose, Art. 49, as drafted, appears to categorically admit the possibility that any negotiable bill of lading issued may, depending on the practical circumstances, lose its document of title function.

Whether contractual clauses could be devised to provide differently is, at present a matter of conjecture. There would seem to be little incentive for carriers to "contract out of" Art. 49, as the provision favours their interests. What is clear is that the proposed solution could have a number of potential repercussions for international sales contracts and their financing. These might prove problematic, as they put in question the central premise underlying documentary sales on shipment terms, namely that performance of a sale contract, in particular performance of the seller's main obligation to deliver the goods (i.e. transfer possession), is possible by way of tender of documents alone. In addition, however, there are practical questions that arise, including the following: assuming that a carrier asks an original shipper for delivery instructions, what is the shipper, who may have no contact whatsoever with the final consignee, to do? The shipper, being a CIF seller or an FOB buyer in the first of a chain of string sales, would have normally already been paid by its own buyer against tender of documents and no longer have any legitimate interest in the goods. Therefore, although expressly "authorized" by Art. 49 of the draft Convention, the shipper should refuse to provide delivery instructions, or risk later becoming exposed to a claim for conversion by the lawful consignee.

If, however, the shipper (or documentary shipper) were to refuse to provide delivery instructions, Art. 50 would become relevant. While proper analysis of the provision is not possible here, it should be noted that Art. 50 provides for extensive rights on the part of the carrier if goods remain "undeliverable", which is the case, inter alia, if "the controlling party, the shipper or the documentary shipper cannot be found or does not give the carrier adequate instructions pursuant to article [...] 49"19. In these cases, the carrier may, after giving reasonable notice20, dispose of the goods in a number of ways, at the consignee's risk and expense. This includes storing, unpacking or even destroying the goods, or selling them on21, in which case the carrier would keep the proceeds in trust, but would be able to deduct "any costs ... and any other amounts that are due to the carrier in connection with the carriage of those goods"22. The carrier would only be liable for loss of or damage to the goods, if the claimant could prove that the carrier had failed to take reasonable steps to preserve the goods and "knew or ought to have known that the loss or damage to the goods would result from its failure to take such steps"23.

As can be seen, the consequences, in cases of delayed arrival of bills of lading, that might arise for a consignee as a result of Art. 49 and Art. 50 of the draft Convention could be rather extreme. While practical solutions might emerge to "soften the blow", such as letters of indemnity being provided by contracting parties in string sales to their respective buyers, or consignees scrambling to speed up transmission of bills of lading, the way the issue is addressed in the draft international Convention appears to seriously undermine the document of title function of the negotiable bill of lading, which is key to its use in international trade. Moreover, it is likely that the interpretation and application of the relevant provisions would give rise to much costly litigation. It is hoped that the relevant provisions will be carefully reconsidered, before the draft Convention is finally adopted.

This article represents the views of the author and not necessarily those of the ICC or any of the other partners in DC-PRO.

1 For the consolidated text, see Annex to document A/CN.9/645, available at www.uncitral.org under Working Group III. All other related working documents can also be found on the website. For an article-by-article commentary by the UNCTAD secretariat on an early version of the text, as well as a note on some aspects see UNCTAD/SDTE/TLB/4 and UNCTAD/SDTE/TLB/2004/2, available at www.unctad.org/ttl/legal.

2 For a good albeit brief overview over the differences between different types of transport documents and for the results of a large-scale survey on commercial practices regarding choice of transport documents, see the UNCTAD report "The use of transport documents in international trade", available at: www.unctad.org/ttl/legal.

3 For an excellent conceptual overview, see Goode, Commercial Law, 3rd. ed., London 2004 at p. 886 et.seq. An overview over relevant case-law on the document of title function of the bill of lading is also provided in the Court of Appeal and House of Lords decisions in The Rafaela S, see next footnote.

4 Note that in English law, a "straight" bill of lading, i.e. a non-negotiable bill of lading made out to a named consignee is now also recognized as a document of title, albeit a non-transferable one, see only J.I. Macwilliam Co. Inc. v. Mediterranean Shipping Co. S.A., The Rafaela S [2002] EWCA Civ 556; [2003] 2 Lloyd's Rep. 113, a Court of Appeal decision later affirmed by the House of Lords at [2005] UKHL 11, [2005] 2 AC 423, [2005] 1 Lloyd's Rep 347. The position is similar in some jurisdictions, but different in others, notably the United States.

5 In some jurisdictions, the negotiable bill of lading is truly negotiable in the sense of providing any transferee with good title, i.e. property in the goods, free from any existing defect in ownership. In English law, the same effect is achieved through statutory provisions, but the document itself is not considered to have the same inherent proprietary value, see Goode, above, and The Rafaela S [2005] UKHL 11, at para. 37 and 38. In English law, therefore, "negotiable" - in the context of a bill of lading - means "transferable". 

6 Notably by Electronic Shipping Solutions, www.essdocs.com. For an overview over past initiatives, see UNCTAD, "The use of transport documents in international trade", above, with further references. 

7 Reference is made here only to the situation where a negotiable transport document, i.e. a negotiable bill of lading has been issued. The draft Convention also provides similar rules regarding negotiable electronic records as well as non-negotiable transport documents and electronic records, but the relevant provisions are less problematic in these contexts.

8 "Holder" is defined in Art. 1 (10) as "a person that is in possession of a negotiable transport document" and is identified as shipper, consignee or endorsee in an order bill of lading or is the bearer of a bearer bill of lading.

9 Compare the definition of "holder" in Art. 1 (10) (a).

10 Art. 49 (b).

11 Art. 49 (d). The provision states: "If the holder … does not claim delivery of the goods at the time or within the time referred to in Art. 45…". It follows from the subsequent provisions of the article that one of the situations envisaged in Art. 49 (d) is where the consignee is not yet in possession of the document when the goods arrive (and cannot therefore claim delivery as "holder") and the document is still being held by an intermediate endorsee who, for obvious reasons, does not claim delivery.

12 Art. 49 (d). The provision states that instructions shall first be sought from the "controlling party". However, the controlling party is defined, in Art. 53 (3), as the "holder" who in turn is defined as "a person that is in possession of a negotiable transport document" and, in the case of an order document is identified as shipper, consignee or endorsee or, in the case of a bearer document is the bearer thereof, see Art. 1 (10). Thus, a consignee who is not in possession of the negotiable document does not qualify either as "holder" or as "controlling party". An intermediate endorsee in possession of the document, such as a bank, would qualify as a holder/controlling party and could be approached for delivery instructions. However, this would require that the carrier was able to identify and locate that party. Possibly it is envisaged that a consignee may help in this process to avoid the carrier seeking delivery instructions from the initial shipper, with whom the consignee may have no contact at all. Another question is what a bank's response to such a request should be, given its obligations under UCP 600 and in particular the principle of autonomy of the letter of credit. 

13 See the definition of "documentary shipper" in Art. 1 (9). Importantly, such a "documentary shipper" assumes all of the contracting shipper's obligations and liabilities under chapter 7 and Art. 57, and is entitled to the shipper's rights under chapter 13 of the draft Convention, see Art. 34. 

14 Art. 49 (e). The carrier is also provided with a statutory indemnity against the party providing delivery instructions and may make delivery conditional upon the provision of adequate security, see Art. 49 (f).

15 Art. 49 (g).

16 A right to compensatory damages would only arise if the consignee could establish breach, on the part of the carrier, of his delivery obligation. This will not be possible if the carrier delivers in accordance with Art. 49 (e). 

17 Art. 49 (h).

18 The term used is "contract particulars". These are defined, in Art. 1 (23) as "any information relating to the contract … or to the goods … that is in a transport document …".

19 Incidentally, it seems that if an intermediate endorsee, such as a bank, were asked for delivery instructions as "controlling party", but refused to comply with the request (cf. Art. 4 of the UCP 600), the carrier would not need to first approach the shipper for delivery orders, but could also proceed under Art. 50. 

20 Art. 50 (3). The carrier may exercise his rights only after giving reasonable notice to the notify party stated in the transport document, as well as the consignee, controlling party or the shipper, if known to the carrier (and in the order indicated).

21 Art. 50 (2)

22 Art. 50 (4). It is not entirely clear what is meant by "any other amounts that are due …", but the provision seems to sanction a broad right of deduction by the carrier. Certainly, there is potential for legal dispute on the matter. 

23 Art. 50 (5)

Dr. Regina Asariotis is Chief of the Policy and Legislation Section in the UNCTAD secretariat (Division for SITE). Before joining UNCTAD in 2001, she was Senior Lecturer in Law at the University of Southampton, and a member of the University's Institute of Maritime Law. She holds degrees from Universities in Germany and the UK and is a qualified Barrister in England and Wales and Attorney at law in Greece. Regina has authored numerous publications in the field of maritime and international trade law.



 

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UCP 600 and Banco Santander

 


DCInsight Vol. 1726 No.2 April - June 2011

 

by Jim Barnes

A New York court recently held that the Banco Santander case was effectively undone by the revisions introduced in UCP 600. The case, Fortis Bank (Nederland) N.V. v. Abu Dhabi Islamic Bank1, is of interest to L/C bankers for its discussion of the effect of UCP 600 on Banco Santander. It is also of interest because it is among the few reported cases involving a "synthetic" or "structured" L/C transaction in which an exporter's or importer's access to 360-day L/C financing is re-directed to a bank.

The confirmation

The defendant bank ("ADIB") advised and confirmed a USD 40 million L/C issued by Bank Awal on the application of Bank Awal's parent company group (the Saad Group). ADIB sent its L/C confirmation to Fortis Bank by SWIFT MT 710. It included a description of goods and permitted places of shipment and destination. It also required presentation of copies of commercial documents (no originals) and included additional conditions that essentially waived all discrepancies other than credit amount and credit expiry. It entitled Fortis Bank to reimbursement at maturity (360 days after acceptance of time drafts drawn by the beneficiary, Bunge, on Fortis Bank) against Fortis Bank's authenticated SWIFT message to ADIB that Fortis Bank had received a complying presentation and forwarded the documents to the issuing bank (not to ADIB). Fortis Bank advised the confirmed L/C, collected ADIB's USD 500,000 confirmation fee, and exchanged SWIFT messages with ADIB as to its negotiation of a complying presentation and reimbursement at maturity.

The fraud defence

Before maturity, it appeared that the Saad group, including the applicant and issuing bank, were in deep financial and other difficulties. At maturity, ADIB refused to reimburse Fortis Bank. ADIB claimed that it had been defrauded by the issuing bank and by the beneficiary and by Fortis Bank as well, because the L/C-financed "synthetic" (or "structured") underlying obligations that had no nexus to any actual export commodity transaction. There was evidence that the L/C might have provided finance to Bank Awal (or its affiliated applicant) and might not have financed the export-import transaction evidenced by the copy documents required by the L/C. Two well-known experts, Pottengal Mukundun and Vincent O'Brien, testified as to the peculiarity of the L/C and its apparent use to raise liquidity rather than to finance the export-import transactions referenced in the L/C.

The court opinion quotes extensively from Mr O'Brien's testimony. He said that, based on his experience, it was probable that Fortis Bank discounted its 360-day acceptance, and Bunge transferred the discounted funds it received from Fortis Bank to Bank Awal, with the ultimate effect of providing 360-day financing to Bank Awal (or its affiliated applicant) on terms indirectly supported by ADIB's L/C confirmation. (Presumably, such financing was related to an in-transit purchase and resale of the goods that Bunge arranged with Bank Awal or its affiliated applicant.) He concluded that such financing is "dressed up" as trade finance because of the generally lower-risk nature of trade finance and its simplicity (e.g., in the documentation of inter-bank obligations).

ADIB also argued that, even if Fortis Bank was not itself engaged in fraud, it could not avoid ADIB's fraud defence. ADIB relied on Banco Santander SA v. Banque Paribas2, in which a confirming bank that incurred and then discounted its own deferred payment undertaking was held to bear the risk of beneficiary fraud established thereafter, but before the maturity date.

The New York court's decision

The court specifically stated that ADIB's reliance on Banco Santander was misplaced in light of changes made in UCP 600. In the Banco Santander case, the English court concluded that under UCP 500 a bank nominated to incur a deferred payment undertaking was not authorized to prepay it. In the New York case, the L/C and confirmation nominating Fortis Bank3 were subject to UCP 600. UCP 600 subarticle 12 (b) added such a right of prepayment that was missing in UCP 500. Accordingly, the New York court concluded that "Because of such revisions, [Banco Santander] has no binding authority." The court also rejected ADIB's fraud defence, essentially on the ground that ADIB should have understood the unusual nature of the L/C and its reimbursement obligation as confirming bank, based on the text of the confirmed L/C, and from its pre-issuance correspondence with the beneficiary and Fortis Bank.

This case was decided on summary judgment. Essentially, the court determined that Bank Awal's sole defence of fraud could not be established as against Fortis Bank, that there was no basis for allowing Bank Awal to discover what Fortis Bank knew about the underlying transactions or even to obtain copies of the documents received and forwarded by Fortis Bank, and that there was no reason to delay ordering Bank Awal to honour its confirmation.

The decision is important and welcome in its application of the fraud exception and UCP 600 on the independence of a nominated bank's reimbursement rights.

Regulatory issues

The court's opinion is focused on the enforceability of a confirming bank's obligations under letter of credit law and practice and does not discuss any possible regulatory issues associated with an L/C confirmation that obscures the nature of the underlying obligation to be satisfied by honour. Regulators might question, for example, whether this or similarly structured L/C obligations qualify as trade finance, Islamic finance or insurable commodity export finance. Regulatory questions either would not arise, or would arise differently, if the L/C and L/C confirmation were drafted as an ISP98 confirmed standby calling for a beneficiary's statement that the applicant was obligated to pay the beneficiary the amount demanded, with or without further identification of the underlying obligation. That confirmed standby structure would clarify and simplify the regulatory, as well as enforceability issues.

James G. Barnes is senior counsel at Baker & McKenzie LLP,
Chicago, Illinois, His e-mail is [email protected]

 

1Index No. 601948/09 (N.Y. Sup.Ct. Aug. 26, 2010). The papers e-filed in the case are available at http://iapps.courts.state.ny.us/webcivil/ FCASMain under Case Index No. 601948-2009. The critical opinion in the case is Document #80. The confirmation is reproduced as an exhibit in Document #58-2. (Many of the other papers concern Fortis Bank's efforts to attach ADIB assets in New York and ADIB's efforts to discover documents from Fortis Bank.)

21 All E.R. 776 (Com. Ct. C.A. 2000).

3ADIB's confirmation called for time drafts to be drawn on Fortis Bank, but also stated that the credit was available by negotiation, and the parties to the litigation frequently refer to Fortis Bank as a negotiating bank that negotiated a complying presentation. The court's opinion focuses solely on the fact that UCP 600 mooted Banco Santander and does not consider the possibility that Banco Santander by its terms applies to a bank that has incurred a deferred payment undertaking and not to an accepting or negotiating bank.

 

 

Renminbi-denominated L/Cs going globaltitle

 

DCInsight Vol. 17 No.2 April - June 2011

by Mark Ford

When China announced the pilot Renminbi (RMB) Trade Settlement Scheme (RTSS) in April 2009, it cleared the way for yuan-denominated trade settlements between certain enterprises on the Chinese mainland and counterparties in countries in the Association of South East Asian Nations (ASEAN) as well as Hong Kong and Macau. Last year the scheme was expanded so that trading partners across the world could participate in yuan-denominated letters of credit and other trade transactions.

 

 

The impacts of the RTSS will be substantial, challenging the US dollar's domination of world trade and establishing the yuan alongside the dollar, euro and yen as a key currency in foreign exchange markets. Whilst there is huge enthusiasm for RMB settlements, bankers canvassed by DCInsight say the current value of this business remains low because of the limited number of Chinese firms participating in the scheme and bureaucratic procedures in the RTSS mechanisms.

Early days

Demand is clearly strong from exporters and importers of goods to and from China for trade finance transacted in the Chinese currency. "Chinese buyers are increasingly telling our exporters that they want to pay for purchases using yuan-denominated L/Cs to mitigate exchange rate risk," one London-based banker told DCInsight. "This is particularly the case with exports where the parties need to agree a stable price over the medium - or long-term," he added.

Another banker said he expected to see as much as 95 per cent of all of China's exports to be covered by the scheme in five years. During the first year of the scheme, only around 0.4 per cent of China's exports were covered by the pilot scheme.

The scope of the original pilot scheme was not large - covering only trades between 450 specified Chinese enterprises in five cities. Only trades between Shanghai, Shenzhen, Guangzhou, Zhuhai and Dongguan with Hong Kong and Macau, as well as transactions between Yunnan and Guangxi with ASEAN countries were allowed.

Nevertheless, the scheme marked a step in China's long-term strategy towards globalizing its currency and reducing the dominant influence of the dollar in world markets. China's current role in foreign exchange markets is not commensurate with the size of its economy and export capacity - due mainly to limitations on the yuan's use in international trade and restrictions imposed on its supply and convertibility.

China has yet to build a financial services infrastructure to truly represent a globalized Chinese currency, and there has been some speculation over the roles of Hong Kong and Shanghai in this respect.

China's 12th five-year plan announced in March 2011 specified that fast-growing financial hub Shanghai will focus on onshore financing activities, while Hong Kong will develop offshore yuan business with help from Shanghai.

World opening

In June 2010, the RTSS was opened up to the rest of the world when enterprises in 20 Chinese mainland provinces and cities were admitted into the scheme.

Nonetheless, the scheme is limited. Chinese companies receiving payments must still be on the list of Mainland Designated Enterprises (MDEs) and validate with their local bank that the transaction conforms to requirements specified by the People's Bank of China.

Trade services offered by banks typically include L/Cs, including standby L/Cs, documentary collections and open account trading. However, RMB transactions are limited to the amount of an actual trade transaction, and payment to MDEs has to be made directly.

International banks such as HSBC, JPMorgan and Standard Chartered have embraced the scheme, typically by promoting trade services in the Chinese currency and launching RMB-denominated current accounts. It is now possible to find RMB-denominated L/Cs arranged by banks in countries including Turkey, South Africa and Russia, as well as in many European, North American and Australasian countries.

Sometimes it is up to countries to make the first move so that L/Cs can be RMB-denominated. In February 2011, Nigeria said it had included the Chinese yuan on the limited list of currencies it allows for trade settlement in the foreign exchange market, thereby enabling Nigerian banks to denominate L/Cs in the Chinese currency.

The HSBC Group reckons to be at the forefront of banks to introduce RMB capabilities and products, having now rolled these out across much of its worldwide network. It claims several RMB firsts - as the first international bank to complete RMB-denominated trade settlements across six continents, the first foreign bank to issue RMB bonds in Hong Kong and the first international bank to offer RMB current account and cheque services.

Growth anticipated

A banker at HSBC Bank Canada, which completed its first Canadian international RMB trade settlement transaction in January 2011, said he expected rapid growth in trade yuan-denominated settlement transactions.

Executive vice president for commercial banking at HSBC Bank Canada, Mark Watkinson is optimistic about the future too. "China's continued, explosive growth in the world trade market will likely result in a significant increase in Chinese imports and exports being settled in RMB," he says.

A London-based banker told DCInsight that he expects to see RMB trade finance growing steadily over the coming months, after which he anticipates stronger growth over the next five or six years as China's currency liberalization plans unfold and impact on world markets.

Some analysts say RMB cross-border transactions will show their strongest increase in the ASEAN region over the next few years, in line with strong growth anticipated in Sino-ASEAN trade. Estimates vary, but one analyst reckons that in five years, yuan-denominated transactions may account for 50 per cent of China's USD 200 billion annual trade with Hong Kong and 30 per cent of the USD 250 billion of trade between China and ASEAN countries.

Pros and cons

The perceived benefits of RMB financing include reduced dependence on the dollar, on which almost all trade flows in the ASEAN region are currently based. There are widespread concerns in Asia about the potentially negative impacts of rising US fiscal deficits and government indebtedness on the long-term stability of the US dollar.

Supporters of reduced dependence in the region on the dollar include secretary-general of the UN Conference on Trade and Development (UNCTAD), Supachai Panitchpakdi. He says Asian countries should increasingly use local currencies in inter-regional trade settlements to avoid currency disturbances stemming from US monetary policies. As well as encouraging more RMB account settlement, he argues for more use of the Indonesian rupiah or the South Korean won in regional inter-trading.

Other benefits of the RMB scheme include the yuan's lower volatility since the global financial crisis compared with the dollar, euro and yen. Yuan-denominated transactions could also help counterparties save costs, since a stable currency should result in reduced currency conversion and hedging costs when traders will no longer need to hold US dollars

But enthusiasm in these early days of RMB trade financing is tempered by the inevitable teething problems of a new system. One banker told DCInsight that the validation process MDEs need to undertake in the scheme means it can take several days to complete a transaction, although she is hopeful that transactions will be executed more quickly once all the parties grow accustomed to the procedures.

Another point made by several bankers is that for the moment, the scheme is limited to too few Chinese MDEs and the that RMB will only take off in a big way when the possibilities for writing yuan-denominated business are extended across China's increasingly vibrant trading base.

 

Letters of credit in the post-crisis era

 

DCInsight Vol. 17 No.1 January - March 2011

by Mark Ford

As the world emerges hesitantly from the global financial crisis, the letter of credit is repositioning itself with some success in the post-crisis era, at least in terms of not losing significant ground to alternative methods of trade finance.

 

By contrast, credit insurance had a very bumpy ride during the crisis and has yet to fully recover. There is evidence of some flight to open account and supply chain financing solutions, while the nascent and still tiny international factoring industry appears to be emerging quite strongly from the financial maelstrom of recent years.

Market conditions

A recent survey by credit insurer, Atradius, confirmed that conditions for trade finance users remain tough worldwide. On 30 September 2010, its latest biannual Payment Practices Barometer reported that businesses - even in countries not severely hit by the financial crisis such as China and Poland - were suffering payment problems.

Many respondents said they had to take specific measures to protect and correct their own cash flow and in some cases postpone payments to their own suppliers. In the UK, where nearly 4,000 firms were canvassed, 59 per cent of respondents reported that customers had requested extended payment terms over the past six months, while 57 per cent of companies surveyed reported delayed payment from customers without prior agreement.

These scenarios suggest that businesses would be gravitating to more secure methods of payment, but according to Marc Henstridge, head of risk for Atradius UK and Ireland, today's trade finance environment is sometimes having the opposite effect. "In some cases, we are seeing more supply chain credit in use, which shows businesses are supporting one another in the face of straitened credit supply from other sources, which is a positive," he says. Nevertheless, he stresses the negative impacts of unexpected payment delays and advises businesses to protect themselves against unforeseen circumstances.

Credit insurance and factoring

Credit insurers had a dire financial crisis, experiencing not only falling premiums but some very substantial claims as well. In terms of sales in 2009, the members of the Berne Union supported USD 1.4 trillion of new business, down 9.7 per cent from the international association of credit insurers' 2008 peak, but a greater overall volume than it recorded for 2007 and preceding years.

Credit insurers remain unpopular in some quarters, since underwriters shied away from risks in autumn 2008 to avoid potentially calamitous losses. At first sight, there appear to be signs of recovery. COFACE, the French-headquartered trade receivables group, reported a net profit of EUR 60 million for the first nine months of 2010, compared with a loss of EUR 166 million in the same period in the previous year. Euler Hermes, the largest credit insurer, is reporting a rise in enquiries.

But the recovery at COFACE is not down to credit insurance. The group says its biggest growth was registered by turnover from factoring, which gained 18 per cent to EUR 85 million, while turnover from insurance increased by just 0.5 per cent to EUR 930 million in the first nine months of 2010.

The relatively very small market for international factoring - worth just EUR 165 billion worldwide in 2009 - fared reasonably well through the crisis. According to Factors Chain International (FCI), the value of international factoring declined by just 6.08 per cent in 2009, half of the contraction of 12.2 per cent in the volume of global trade that same year as calculated by the World Trade Organization (WTO).

L/C values

In comparison, the average value of L/Cs - although it initially plunged 19 per cent between December 2008 and March 2009 - declined by just 4 per cent between December 2008 and September 2009, according to SWIFT.

ICC's Rethinking Trade Finance 2010 Survey confirmed this trend. It found that around 60 per cent of respondents indicated that the value of trade finance activity they handled had decreased between 2008 and 2009.

But as SWIFT points out, it has not all been gloom and doom. From a regional perspective, Asia Pacific showed the largest and most consistent increase in L/C average value of 25 per cent over its survey period. By contrast, the Europe non-euro region, a region with a high average L/C value, saw a significant decrease of 31 per cent.

Factoring and L/C outlooks

International factoring has seen the strongest growth in Asia as well. The secretary general of FCI, Jeroen Kohnstamm, says the largest percentage growth has been seen in inter-Asian trade and describes a "remarkable growth of import factoring" in countries such as China and Taiwan.

 

Factors see recent growth as an encouraging sign that international traders are becoming more familiar with the advantages to be derived from factoring, while respondents to the ICC Survey also thought the future looked bright in terms of demand for traditional trade finance products. Specifically, these respondents thought demand for commercial L/Cs, standby L/Cs, guarantees and collections would be sustained in 2010, a view supported by anecdotal evidence of the year's results. A majority of 84 per cent of respondents anticipated an increase in demand for traditional trade products, while 93 per cent were confident they could meet increased demand for these products.

New partnerships

In some instances, the financial crisis has created new environments in which the L/C and credit insurance markets are often collaborating. This particularly appears to be the case in transactions between emerging market issuing banks and confirming banks in OECD countries. During the crisis, the appetite of banks in developed countries to partner emerging market banking risks diminished, causing OECD banks to take out public or private insurance.

One French banker told DCInisght this remains a commonly used technique, and it is one that has propelled export credit agencies (ECAs) into key arenas in the post-crisis trade finance market. Documentary credit insurance is now provided by ECAs worldwide.

Respondents to the ICC Survey indicated that trade facilitation programs, such as those offered by ECAs and multilateral development agencies, are providing valuable trade support, a view shared by a finance director of a large European shipbuilder who said he was "very positive" about the role his ECA had provided. However, he did add that his firm sometimes found it difficult to come up with additional security requirements demanded by the ECA.

Several ECA facilities are only just coming on stream. The UK's Export Credits Guarantee Department (ECGD) only signed up the first participant in its Letter of Credit Guarantee Scheme in August 2010. ECGD will help Spooner Industries deliver a EUR 5 million export order for equipment for the paper industry to the Philippines. Perhaps the most notable feature in the deal is the public-private risk sharing. ECGD guaranteed EUR 1 million of the EUR 2 million trade facility provided by Lloyds Banking Group.

Public-private risk sharing is becoming increasingly frequent in post-crisis trade finance. Citigroup, for example, recently signed up with the International Finance Corporation (IFC) and the African Development Bank in a USD 300 million scheme under the Global Trade Liquidity Programme (GTLP). The innovative shortterm, revolving nature of the assets could generate up to USD 1.5 billion in trade finance for African traders.

These partnerships are helping the L/C regain pre-crisis positions and establish new niches. However, documentary credit professionals should be aware that other types of trade finance are also being encouraged by public-private partnerships. The IFC, for example, is partnering Russia's Transcapitalbank and Malta's FIMBank to establish a new factoring company.

The question of what form of trade finance will dominate in future is still very much up in the air.

 

Incoterms® 2010 have been adopted by ICC

 

 by Frank Reynolds

On 16-17 September, the ICC Executive Board adopted the final version of Incoterms®2010, which will come into force on 1 January 2011.

The Drafting Group met a total of 12 times, including the November 2007 Commercial Law and Practice (CLP) Commission meeting when the decision to revise Incoterms® was made, and the May 2010 when the fourth draft was approved. Each of the over two thousand national committee comments were reviewed for possible inclusion in the three draft revisions that preceded the final version.

There were several unusual situations during the revision. Unlike previous Incoterms® revisions, we followed the CLP schedule and met for several days each in Lyon, Vienna, Helsinki, Brussels and Prague, as well as multiple times in Paris and London. The decision to change was not without strong opposition within the CLP. However, in the end, several of the most outspoken revision opponents became its most active contributors. Also, we lost our Swedish delegate towards the end of the revision for the best of reasons: he was appointed to serve as a justice on that country's Supreme Court.

As the only non-lawyer on the Drafting Committee, I was pleasantly surprised by the interest and at times deference shown to commercial practice. We even toured a seaport to see for ourselves the way things really work.

Changes

The following changes will demonstrate that Incoterms® 2010 is truly a major revision:

- The layout differs from all previous versions. Omnimodal and vessel-only rules are covered separately, thereby reducing the likelihood of improper use of marine rules for air and ground transport. Also, this version is written in gender-neutral style. While that may require some getting used to, it is definitely modern writing technique.

- Since many Incoterms® users failed to read the Introductions in previous versions, the Introduction has been streamlined to bare essentials.

- Individual Incoterms® 2010 are now accompanied by guidance notes, which are more likely to be read because of their location near the rules themselves.

- Taking a cue from UCP 600, Incoterms® 2010 provide definitions for key terms in their Incoterms® context. Key words like "delivery," "carrier" and "packaging" are now defined in the Introduction.

- The former Delivered At Frontier (DAF), Delivered Ex Ship (DES) and Delivered Duty Unpaid (DDU) were deleted, and have been replaced by one new Incoterms® 2010 rule, Delivered At Place (DAP). This should accommodate all the situations where the old rules were commonly used (see below).

- DDU was quite popular. The only issue was with the "Unpaid" part of its name, which made it difficult to use with domestic sales of pre-cleared imported goods. In these situations, the ever-dangerous Delivered Duty Paid (DDP) was actually more appropriate. As DDP could result in unfortunate situations when used by inexperienced domestic persons in international transactions, the decision was made to "duty neutralize" DDU by including it in the new DAP.

- The former Delivered Ex Quay (DEQ) has been expanded to accommodate all manner of transportation as the new Delivered At Terminal (DAT) rule. This now becomes a rule under which the seller is responsible for the unloading of aircraft, lorries, etc., as well as vessels.

- All reference to the "ship's rail" has been removed from the FOB, CFR and CIF rules. This effectively changes the delivery point to "on board" for these rules. Sellers and buyers are urged to define exactly what this means in their purchase/sales contracts, as this can vary by product type or from one contract of carriage to another.

- A potentially dangerous situation resulting from the default position of delivery to the "first carrier" in the CPT and CIP rules has been described. We couldn't change the default, as it mirrors what is contained in the UN Convention on the International Sale of Goods and other major bodies of law, but we were able to suggest remedies.

- Container loading is specifically not covered as "packaging". Sellers and buyers are cautioned to cover this important task elsewhere in their purchase/sales contracts.

- Cargo security information obligations have been assigned to both buyers and sellers for the first time. Because of the many different and ever-changing security regimes, our coverage is limited to informing the parties that these regulations exist and that they must consult with each other to ensure compliance.

- Insurance is covered in greater detail than ever before. The recent revisions to the LMA/IUA Institute Cargo A, B, War and Strike Clauses are mentioned as possible additions to the "minimum cover" C clauses.

Recommendations not included

There were two insurance-related recommendations with wide support that we couldn't accommodate. The first was a request that the default position for CIP and CIF be changed to maximum cover rather than the current minimum cover. The problem here was how to define "maximum cover", since much insurance is written around the needs of individual assureds and particular industry practices. We mentioned at every opportunity that the default position is minimum cover, and that the parties could consider additional cover, citing the more extensive and recently revised Institute Cargo Clauses by name.

The second request was for a rule whereby the seller would insure but the buyer would handle transportation. Insurers pointed out that they would then be asked to cover shipments for which they or their customers had no first-hand information, let alone any potential for loss reduction practices commonly employed by insurers and assureds.

While we couldn't satisfy all requests - some, in fact, contradicted others - it is the unanimous opinion of the Drafting Group that Incoterms® 2010 are a definite improvement and are consistent with the way trade is conducted throughout much of the world. We'll see how they stand up over time.

Frank Reynolds is President of International Projects, Inc. in Ohio (US). His e-mail is [email protected].

 

 

The Future of Trade by Michael Quinn is Managing Director, J.P. Morgan Global Trade. 

Until 2008, when the music stopped for global trade, the first decade of the twenty-first century could be described as the Roaring Two's. World GDP grew at better than 3.4 per cent per year, with trade in goods and services enjoying 9-12 per cent growth annually.

 

As trade surged, liquidity flooded the international markets, and in the rush to keep pace with rapidly growing trade flows, traditional risk mitigation techniques took a back seat to getting deals done. Participants were confident of anticipating problems and taking steps to remediate issues long before settlement came due.

Banks with limited trade finance experience joined the fun and became international financiers overnight. As was the case in all other asset classes, the money chasing investment opportunities led to reduced due diligence and falling returns. And as returns fell, players became even more aggressive, financing deals with limited knowledge and even less expertise.

Bad times

In mid-2007, real estate values flattened and began to fall in some US and Europe markets. Commodity prices, which had fueled the absolute dollar value surge in global trade, began to flatten too.

By the end of 2008, a massive deleveraging was sucking all liquidity from the markets. Balance sheet strength was not enough to prevent financial institutions from being buffeted by the storms racking global markets. Governments were forced to intervene, using both monetary policy and direct intervention to calm the waters.

The global economy entered its deepest recession since World War II. Global trade ran aground as economic retrenchment took hold and reduced demand for goods and services. Uncertainty about the economic viability of trading partners prevented engagement in any meaningful commerce. Where viable transactions did exist, there was no financing available for them: the primary and secondary markets froze completely and risk appetite was literally at zero.

Although aggressive actions were taken by central banks and multilateral agencies, breaking the cycle would take nearly 15 months. Liquidity was made available in hopes of stimulating minimal levels of trade. Trade finance facilities were made available by local Export Credit Agencies and the financing arms of global multinational organizations. Banks not as dramatically affected by the downturn loaned aggressively - primarily to financial institutions that had been their traditional trade counterparties - not only to help facilitate trade, but to help sustain their own viability.

Recovering

In 2010, year-on-year trade growth is forecast to be 9-10 per cent against an extremely low base, with restoration to pre-crisis levels still projected as a 2012 event. Commodities have stabilized and there are signs of increasing demand and higher prices. Some regions have bounced back from the crisis more quickly than others. Asia fared best because, while overall trade fell, intra-regional trade continued to demonstrate strength. Latin America has borne up well this time, with Brazil demonstrating particular resilience. Turkey has proved a regional standout and functions as a gateway between Europe and the Middle East and Maghreb emerging markets.

Surviving financial institutions have been recapitalized through the markets or direct government intervention. Profitability has been restored in most financial markets, and there is new willingness to lend. Secondary markets are reviving, albeit at only at 60 per cent of pre-crisis levels. The price of risk, which peaked in the first quarter of 2009, has begun to fall and in some markets has returned to pre-crisis levels. Well-capitalized customers continue to have access to the capital and debt markets, but access to capital remains problematical for lower middle market and sub-investment grade borrowers.

In this "back to basics" business environment, highly structured and securitized transactions have declined significantly as accounting rules and investor scrutiny have forced bankers to return to transparent structures. Financing is linked more tightly to the ultimate source of repayment. Documentation standards have been raised to include stronger terms and conditions.

Rebounding

What do we think the future holds? My crystal ball shows global trade rebounding. During the next 12-18 months, trade volumes will likely claw their way back to the levels seen pre-crisis, with accelerated growth continuing in 2013 and beyond. As supply and demand return to their natural balance, markets will resume globalization, and we will probably once again experience the optimism and vibrancy of the early 2000s.

The explosion in global trade over the past decade created globalized, intrinsically linked economies whose interdependencies were as evident in the collapse as they were in growth cycles. These interdependencies cannot be reversed, even if isolationism and protectionism rear their heads in certain countries or regions. We have learned over the years that such restrictions cannot be sustained. Entrepreneurs will find ways to circumvent those barriers in order to make the best product at the best price. Capital flows will continue to seek the best returns, regardless of local legal and regulatory challenges.

Intermediation of country risk had been losing importance pre-crisis and will continue to decline in the post-crisis era. Businesses become more comfortable with cross-border risk as they globalize. While still an impediment to trade, local legal and regulatory regimes are increasingly transparent and can be managed with the appropriate mix of information and people on the ground. Country events, like the political upheaval in Thailand and natural disasters in Pakistan, may temporarily disrupt trade, but alternative channels will develop quickly and efficiently.

The price compression we have seen in the industry will no doubt continue. Customers view plain-vanilla L/C processing as a commodity and will take any competitive bid. With the development of capital markets in emerging economies, suppliers are much less dependent upon the L/C as a credit enhancement for packing loans or pre-export financing.

Letters of credit or other documentary trade products will continue to be utilized when parties involved in a cross-border transaction are new to each other, or when one of the parties is domiciled in a "tough" or highly regulated country. The robust and time-tested body of rules and regulations governing transactions under these instruments will continue to preserve the rights of the various parties and provide consistency in outcomes. Also, as noted in the most recent crisis, the cyclical nature of economies will drive usage depending upon the severity of the downturn.

Crisis as opportunity

"Don't let a perfectly good crisis go to waste" is good guidance in our current circumstances. This recovery is when the future of trade can best be defined.

As they envision the next wave of trade, banks should focus on customers holistically in order to gain understanding of their end-to-end business. This new kind of relationship changes the traditional trade bank's role - "only dealing in documents" - to a new concentration on underlying commercial transactions. From J.P. Morgan's perspective, it means focusing on the customer's supply chain and finding the means to integrate financial and physical activities.

Partnership paradigm

By focusing on the supply chain, we gain visibility to business processes and understand at what point responsibilities begin and end among the parties and when there is contractual or process-driven "commitment" to pay. Looking at commercial risks provides better understanding of when mitigants are required and how they can best be applied as a by-product of the commercial transaction. Success in global trade lies not only with buyers and sellers, but also with servicers and other parties whose coordinated effort is required to deliver value to the end user/consumer. Full knowledge of their interdependencies helps further reduce risk.

The success of integrating finance and commerce is measured by its impact on the parties' bottom line. Optimizing working capital is the end game, and winning means effective management of all aspects of payables, receivables and inventory. Financiers need the ability to leverage the strongest credit in various points of the supply chain to inject liquidity at the right time and in the right place. In the absence of traditional trade instruments, risk mitigation, liquidity and settlement capabilities must be available to the right parties at the right time and at the right price. Value comes to the provider from leveraging technology platforms that support visibility to the transaction through data management. In this new world, trade bankers need to extricate themselves from the paper-handling morass and instead confirm compliance with L/C terms by leveraging supply chain information.

Globalization is now all about outsourcing, alliances and leveraging centers of excellence in ways that are mutually beneficial. Trade banking customers have learned to capitalize on high-quality skilled resources wherever they reside. Banks need to recognize their own weaknesses and partner with firms that help them add value by collaborating to solve problems for the customers they share. In the pre-crisis world, we saw some ill-prepared banks entering trade finance with little more than a fat wallet. In the new world, these participants can provide liquidity in their home markets in conjunction with a facilitator with deeper experience of global markets and supply chains.

Banks must find a niche within their customer's ecosystem. Why shouldn't they become an extension of their customers' business processes and provide value in multiple stages? The customer's payables process increasingly blurs the line between international and domestic settlement. Banks must be able to intermediate both within a single business process. Banks excel at reconciling and controlling processes. Isn't it reasonable to think they can eventually take over the customer's order-to-cash cycle from shipment through collection and invest the resulting proceeds? This is the thinking of the futurists who are focused on flourishing in the future of trade. And the future, as we would probably all agree, starts tomorrow.


How politics shapes letter of credit flows

L/Cs and politics are a potent mix. In fact, political considerations have shaped aspects of the letter of credit market for decades.

 

At the geopolitical level, the United Nations used L/Cs to regulate the oil-for-food program that marginalized Iraq under Saddam Hussein from 1995 to 2003. In 2009, the G20 leaders mobilized multilateral development banks and national export credit agencies to make L/Cs more available in a world where trade finance was drying up. In Africa, obtaining L/Cs without having to resort to western banks has been a strategic objective for the Common Market for Eastern and Southern Africa (COMESA) for several years.

 

 Bilateral trade can be boosted by L/C agreements as well. In recent years, Thailand has entered into bilateral trade agreements with India and separately with Malaysia to improve L/C flows. In 2009, high-level talks between Bangladesh and Myanmar - where L/Cs have been hard to come by for the better part of a decade due to international sanctions - contemplated the use of direct L/Cs to boost trade between the two countries.

Country-specific policies can also affect the L/C market. Pakistan and India have used legislation to increase or decrease the cost or even to ban L/Cs in order to shape trade flows of specific commodities between their countries. Algeria passed controversial legislation in 2009 insisting on the use of L/Cs to curb imports, only to ease this requirement in September 2010. The Philippines legislated to make L/Cs available at a wider range of financial institutions.

Geopolitical contexts

More uses of L/Cs in a geopolitical context can be expected soon. On 18 July 2010, responding to substantial US pressure, Pakistan and Afghanistan announced a landmark trade partnership that aims to boost the regional economy and undermine the efforts of insurgents to destabilize the two countries' governments. The deal, which was announced shortly after US Secretary of State Hillary Rodham Clinton visited Islamabad, would give landlocked Afghanistan sea access and provide Pakistan with direct road links to other Central Asian economies. As of this writing, the deal has yet to be ratified by both countries; however, it has been in the offing for years, and L/Cs may be called upon to make it work.

The forerunner of the deal is the Transit Trade Agreement signed last year by the two countries. Under that scheme, Islamabad grew concerned about goods supposedly passing through the country on a duty-free basis and being smuggled into Pakistan. This led for calls for L/Cs to be used in this transit trade to curb the smuggling.

Iran's nuclear ambitions

Probably the most noticeable current use of L/Cs in a geopolitical way is driven by international concerns over Iran's nuclear ambitions. Sanctions applied to Iran - particularly those imposed by Washington - have made L/Cs very scarce, not only for businesses in Iran, but also those in Dubai where a sizeable Iranian trading community operates. Traders there are reportedly moving operations further afield to countries like Malaysia and Turkey, where there are fewer difficulties.

According to local sources, rather than spending time and money trying to work out whether their clients' activities fall within the scope of transactions allowed under various sanctions regimes, Dubai's banks are dropping some Iranian customers.

Indeed, more sanctions on Iran are emerging. On 9 June 2010, the UN Security Council imposed its latest set of sanctions on Iran. These call for member states to prohibit financial institutions within their territories or under their jurisdiction from opening representative offices, subsidiaries or bank accounts in Iran if these outlets could contribute to Iran's nuclear program.

The UN measures came within days of US President Barack Obama's approving legislation imposing new unilateral sanctions that will affect companies and banks dealing with Iran and block sales of petrol and other petroleum products to the country.

New EU measures introduced in July also target the oil and gas sector and bar new European investments in major sectors of the Iranian economy. Tighter scrutiny of Iranian banks operating in the EU means money transfers of more than EUR 10,000 must be declared, while transfers of amounts exceeding EUR 40,000 will require authorization.

Lifting sanctions

Sanctions imposed by Washington on countries it considers bad actors - including Syria, Zimbabwe, Cuba, Somalia and Myanmar - can have a severe impact on a country's economy, and some have been around for years. Washington first imposed sanctions on North Korea in 1950.

But sooner or later, sanctions are lifted, and sometimes unexpectedly. Following nuclear testing programs by both India and Pakistan in May 1998, former US President Clinton's administration imposed trade and economic sanctions on both countries. The sanctions restricted credit, guarantees and financial assistance, including L/C-based trade transactions.

However, in September 2001, less than a fortnight after the 9/11 terrorist attacks on New York and Washington, former President George W Bush waived these sanctions. Analysts saw the waiver as a clear example of how the rest of US foreign policy - in this case, fears of nuclear proliferation - was being subordinated to the campaign against terrorism.

Now there are signs that Washington is considering lifting sanctions on Cuba that require agricultural exports to the island to be paid for through L/Cs from a third-party financial institution in another country or by cash in advance. In 2009, the Obama administration eased travel restrictions to Cuba, and US farmers are lobbying hard for Washington to lift sanctions that apply to L/C usage. "If we could establish L/Cs here, it would help tremendously," one US apple grower told local media. "I don't think we are going to eliminate the [trade] embargo right away, but we can certainly take small steps toward that."

Sanctions and penalties

The willingness of the US to crack down hard on violators of sanctions was highlighted in May 2010 when the Royal Bank of Scotland (RBS) said it would pay a fine of USD 500 million for breaches of the Bank Secrecy Act and sanctions violations committed by the now-defunct ABN Amro. Investigators found that between 1995 and 2005, the bank removed or changed interbank transaction data on entities blacklisted by the US. ABN Amro's New York branch was accused of "wilfully" ignoring Bank Secrecy Act requirements and for having processed over USD 3.2 billion of business with banks in Iran, Cuba, the Sudan and Libya.

The fine followed a penalty imposed in 2006 on ABN Amro - which is now part of RBS - when it was ordered by US officials to pay fines totalling USD 80 million for transactions that US banking regulators say violated money laundering laws and sanctions imposed on Iran and Libya.

The largest penalty to date emerged in December 2009 when Credit Suisse agreed to pay US authorities USD 536 million for stripping documents showing Iranian involvement. The bank processed USD 700 million for blacklisted Iranian entities between the mid-1990s and 2006.

In another case, in 2009 a USD 350 million deferred prosecution agreement was made against Lloyds TSB Bank over charges that its London and Dubai branches falsified and omitted data in wire transfers for Iranian banks.

Individuals may also be liable for failing to comply with sanctions from the US Treasury's Office of Foreign Asset Control (OFAC). According to Deloitte, private banks having transactions involving US currency, checks, wire transfers and L/Cs may have significant exposure to sanctions imposed by the US via OFAC. Violations could lead to criminal prosecution with penalties ranging up to ten years in prison.

Politics and L/Cs may make strange bedfellows, but the links between the two are clearly here to stay.

 

 

Straight versus Order Bills of Lading

Straight Bill of Lading

In a straight bill of lading---non-negotiable bill of lading---the title to the goods is conferred directly to a party named in the letter of credit (the importer usually), as such the title to the goods is not transferable to another party by endorsement. In other words, the bill of lading is not negotiable.

 

The letter of credit calls for a straight bill of lading usually by using such words as "consigned to [the named party]" or "issued in the name of [the named party]". The named party can obtain the goods directly from the carrier at destination. Therefore, unless the cash payment has been received by the exporter or the buyer's integrity is unquestionable.



Order Bill of Lading

In an order bill of lading---negotiable bill of lading---the title to the goods is conferred to the order of shipper or to the order of a named party in the letter of credit (the issuing bank usually).

 

The purpose of an order bill of lading is to protect the interest of the shipper or the named party to the title to the goods.

 

The title to the goods is transferable to another party by endorsement, usually on the reverse (back) of the bill of lading (B/L) by the title holder of the B/L. If the endorsement of B/L is required in the letter of credit (L/C), all the originals must be endorsed.

 

The letter of credit may calls for an order bill of lading that is:

(1)    To order blank endorsed or To order of shipper and blank endorsed,

(2)    To order of shipper and endorsed to order of [the named party], or

(3)    To order of [the named party (other than the shipper)].

 

To order blank endorsed or To order of shipper and blank endorsed

 

Unless provided otherwise, a consignment that is "to order" means to order of shipper. The "blank endorsed" means without specifying to whom the bill of lading (B/L) is transferred. In such instance, whoever bears the B/L after endorsement holds the title to the goods.

If the sample letter of credit requires a B/L that is "to order blank endorsed", as such enter the words "To Order" in the Consignee field in the bill of lading and other documents/forms.

 

In a "to order blank endorsed" bill of lading (B/L), technically speaking whoever bears the B/L after its issuance holds the title to the goods.

 

If the sample letter of credit requires a B/L that is "to order of shipper and blank endorsed", as such enter the words "To Order of UVW Exports" in the Consignee field, since the shipper in such L/C is UVW Exports.

 

In both the above sample cases, the B/L must bear blank endorsement of the shipper as follows:

 

UVW Exports
(plus the authorized signature)



And, entering the words "To Order" or "To Order of UVW Exports" in either of the above cases is correct, but to avoid rejection of documents, always follow the wordings stipulated in the letter of credit as a precaution.

 

To order of shipper and endorsed
to order of [the named party]

 

This letter of credit (L/C) requirement resembles the "to order of shipper and blank endorsed", except that the words "To Order of [the named party]" must be indicated over the shipper's endorsement.

 

If the sample letter of credit requires a bill of lading that is "to order of shipper and endorsed to order of The Moon Bank", as such enter the words "To Order of UVW Exports" in the Consignee field in the bill of lading and the endorsement as follows:

 

To Order of The Moon Bank

UVW Exports
(plus the authorized signature)

 

To order of [the named party (other than the shipper)]

The named party under this letter of credit (L/C) requirement most often is the issuing bank. The L/C does not call for an endorsement, thus the exporter does not have to endorse the bill of lading.

 

The sample letter of credit requires a bill of lading "to order of The Sun Bank, Sunlight City, Import Country", as such enter the words "To Order of The Sun Bank, Sunlight City, Import Country" in the Consignee field in the bill of lading and other documents/forms.

t!

The phrase "forwarder's bill of lading not acceptable"

With the rapid growth of freight forwarders, it is not surprising that transport documents issued by freight forwarders represent a considerable percentage of the documents presented to banks. Nor is it surprising that freight forwarders often act "as carriers". Their dual role as agent and/or carrier, how ever, still puzzles some bankers, which keeps the issue of forwarder transport documents in the spotlight.

UCP 500 article 30 stipulated the circumstances under which a freight forwarder's transport document could be acceptable. Even though UCP 600 makes no reference to freight forwarders, the new sub-article 14 (l) states that the issuer of a transport document can be any party other than the carrier, provided it meets the requirements of the transport articles in the rules.

However, what continues to concern bankers is the fact that many L/Cs subject to UCP 600 require that a bill of lading incorporate the additional condition "forwarder's bill of lading not acceptable". In my view, this condition adds no value, clouds the transparency of the credit, is apt to be confusing and hinders the efficiency of L/C processing.

Case study

Recently, an L/C required a bill of lading with the additional condition "forwarder's bill of lading not acceptable" The presented bill complied with UCP 600 article 20 and was signed as follows: ABC Logistics on behalf of the carrier: APL. The document was dishonoured by the confirming bank, which stated "forwarder's bill of lading presented".

The beneficiary obviously disagreed and argued that it never had indicated that the document was a "house bill of lading", and therefore it should not be treated as a freight forwarder document. However, the con firming bank said it should have been signed by the carrier if the credit required a bill of lading and simultaneously stated "freight forwarder's bill of lading unacceptable". It also argued that if this was not the case, why did the L/C need to add such an additional condition?

My point is not to debate whether this was a valid discrepancy, but to draw attention to the causes that led to this conflict.

ISBP

ISBP is silent about the phrase "forwarder's bill of lading not acceptable"; indeed, freight forwarder is never defined in the ISBP. However, its reverse counter part, the terminology "forwarder's bill of lading acceptable" is addressed. ISBP 681 paragraph 95 states that when an L/C allows for a forwarder's bill of lading, a freight forwarder can sign the B/L in the capacity of a freight forwarder without identifying itself as carrier or as agent for the named carrier, i.e., a forwarder bill of lading can be silent about the carrier. However, if an L/C requires a bill of lading but says "forwarder bill's of lading not acceptable", several questions arise:

- How does one identify a freight forwarder?

- Should the B/L be signed "as carrier" only?

- Can the B/L be signed as "an agent for a named carrier"?

- Is a forwarder barred from signing the document?


These questions can be divided into two categories, the first linked to the issuer's identity, the second to the issuer's function, i.e., the capacity in which it is acting.

Differing perceptions

There can be a number of answers depending on one's perceptions. In its reading of the case above, the beneficiary read the phrase on its face and assumed that the B/L should not be entitled a "house bill of lading". However, the bankers took it differently. They argued that since a presented document, however named, was the principle governing UCP articles19-25, the title of the B/L was irrelevant.

When an L/C requires a bill of lading and is silent as to a freight forwarder, UCP 600 article 20 would be applicable. A presented document that complies with UCP 600 article 20 and is signed by a forwarder as an agent for the named carrier (as above) was surely acceptable, since UCP 600 sub-article 14 (l) explicitly permits a transport document to be issued by any party other than the carrier provided it complies with the applicable transport articles.

However, what concerned us was the combination of the phrase "forwarder's bill of lading not acceptable" with the requirements of UCP 600 article 20. Such a link appeared to open a variety of possibilities and to create some unexpected problems.

UCP 600 articles 19-25 are silent as to the issuer of a transport document; they only stipulate how to sign them. Therefore, in this case the wording "forwarder's bill of lading not acceptable" gave some bankers a hard time figuring out how to apply the rules of UCP 600 in examining documents.

Some bankers who linked the phrase to the issuer's identity might treat it as overriding UCP 600 sub-article 14 (l) and article 20, i.e., they could claim the B/L should not be signed by a forwarder even if it signed as carrier or agent for a named carrier. In other cases where the phrase was considered to be linked to the capacity of the issuer, the confirming bank's position in the case study, the condition was taken as evidence that the B/L should be signed "as carrier", which would be another way of overriding article 20.

One wonders, therefore, how all this will turn out if each party draws a different conclusion from this phrase. In some situations, when an L/C involves a confirming bank that bears some operational risk in document examination, the bank will be more exposed if the situation is too difficult to predict.

ICC perspective

Several ICC opinions address the questions raised by "forwarder's transport document unacceptable", but they mainly respond to specific cases and may not cover all situations that can arise from the use of this phrase. Among these, Opinion TA 572 is typical.

In this case, the L/C called for an ocean bill of lading with an additional condition that "transport document issued by freight forwarder not acceptable". The presented document was entitled "FBL BIFA Negotiable FIATA Multimodal Trans port Bill of Lading" and was signed "as carrier". It was refused by the issuing bank on the grounds that the document was issued by a forwarder. The question was whether this was a justified refusal.

The ICC Banking Commission said that the terminology "transport document issued by freight forwarder not acceptable" was an ambiguous term that does not clearly define the type of document that would be acceptable. With regard to this enquiry, the Banking Commission said that the bank would be obliged to accept a bill of lading that was signed "as carrier" irrespective of any knowledge it may have as to the capacity of the issuer.

This raises the question: what if the document had been signed "as the agent of a named carrier"? Would it be still compliant?

A complementary opinion was Opinion TA 621. The L/C required a master air waybill. The document was signed by an IATA agent as the agent of a named carrier. The air waybill was refused for a similar reason: "HAWB presented". Was this a valid discrepancy? The Banking Commission's conclusion was: "The underlying letter of credit called for a 'Master Air Waybill'. The intent behind such a condition is unknown nor are the expectations of the issuing bank in relation to its issuance or signing... The document would not be considered as discrepant for the reason stated."

Note that this document was actually signed by a forwarder as the agent of a named carrier. As ICC Opinion TA 621 (the master air waybill case) and ICC Opinion TA 572 (transport document issued by freight forwarder not acceptable) are, by their nature identical, this document was also compliant for reasons similar to those outlined in TA 572 1.

The conclusions of these opinions appear to indicate that the phrases "freight forwarder transport document not acceptable" or "house bill of lading unacceptable" or similar wording will be treated as ambiguous. A document signed by a forwarder would be acceptable provided it complies with the applicable transport articles.

Conclusion

In sum, the phrase "forwarder's bill of lading not acceptable" is too vague to be effective in L/C operations. Based on the current ICC opinions, to incorporate this term in an L/C is insufficient to prevent a bill of lading from being signed by a forwarder; it only leads to confusion due to the parties' different concerns and misinterpretations.

Still, the ICC position on this issue has not yet been clearly perceived and universally accepted by L/C users. In fact, many L/Cs still incorporate the phrase. To achieve predictability and more certainty in L/C processing, ICC's position should be underlined when ISBP 681 is revised.

Sheilar T. Shaffer is Senior Documentary Manager of Import/Export Documents at the International Department of Agricultural Bank of China, Shantou Br.
Her e-mail is [email protected]

China leads recovery of developing economies 

DCInsight Vol. 16 No.2 April - June 2010

By Mark Ford


Nearly a decade ago, Goldman Sachs predicted that the combined rapidly developing economies known as the BRICs - an acronym of Brazil, Russia, India and China - could eclipse the combined economies of the world's richest countries by 2050.

That prediction may be challenged by Russia's recent economic performance. The country had the worst performing BRIC economy in 2009 with an estimated GDP decline of at least 8 per cent. Brazil too saw GDP decline by 5.5 per cent, but India and China continued to justify claims to be the locomotives of the global eco no my. In 2009, China's and India's GDPs grew by 8.3 per cent and 6.5 per cent respectively.

Examining the letter of credit markets in these four countries seems to underline the relative fortunes of each of these BRICs.

Russia

After two very difficult years, Russia appears to be depending substantially on external support as it seeks to revive its international trade. In February, the International Finance Corporation (IFC) increased the amount of its facility for the Credit Bank of Moscow (CBM) by US$40 million under the Corporation's L/Csupported Global Trade Finance Program (GTFP).

In November, the European Bank of Reconstruction (EBRD) - which runs the acclaimed L/C - oriented Trade Finance Program - said it would step in and acquire a minority equity stake of 11.75 per cent in Promsvyazbank, Russia's third largest locally owned private bank. The transaction makes EBRD an equity investor in no fewer than 12 Russian banks.

Multilateral development bank interventions, such as those represented by IFC's and EBRD's L/C guarantee schemes, have attained a higher profile since the G20' s muchpublicized goal of making US$250 billion available for trade finance. These programs may well have helped L/C flows in BRIC countries where, according to a World Trade Organisation report in March, average L/C prices have fallen to 0.71.5 per cent from 1.52.5 per cent a year ago.

Regional development banks are also emerging to help boost trade finance flows. Trade finance is a priority for the Eurasian Development Bank (EDB), established in 2006 by the Russian and Kazakh governments to boost investment across the former Soviet Union. Member states now include Armenia and Tajikistan. In February, Russia's VTB Bank and EDB agreed an accord in which the banks are expected to jointly fund various projects, including plans to develop trade finance.

Brazil

Brazil is also using the GTFP to boost L/C availability. In December, the IFC added Banco WestLB do Brasil to the program. The bank will begin using it to support commodity exports in two export financing deals totalling US$18 million. By using the program, WestLB do Brasil plans to provide more export finance to intro duce its clients to new markets.

Organic growth seems to be returning to the Brazilian trade finance market.

According to its executive vice president, Milto Bardini, Brazilian bank BicBanco, which pulled off a 280 per cent increase in fourth quarter 2009 profits over the same quarter in 2008, is bullish about its prospects for trade finance. Bardini told BNamericas that if the exchange rate is maintained, trade finance should soon make up 22-25 per cent of bank's portfolio.

India

Demand for L/Cs in India appears to be growing, due to the improved availability of US dollars in the overseas market and renewed confidence in the banking sector. According to the Business Stand ard, the country's banks are experiencing a surge in demand for certain shortterm trade finance facilities, including L/Cs opened by buyers of Indian goods.

India has hugely ambitious plans to boost exports. The Foreign Trade Policy (FTP) 20092014, which sets out a raft of measures to facilitate Indian exports, aims to stimulate annual export growth of 15 per cent. This means that by 2014, India expects to double its exports.

Exim Bank of India is a key player in the FTP and a participant in the GTFP. India's export credit agency provides confirmation of L/Cs under the GTFP, while the IFC provides guarantee facilities to cover confirmation of L/Cs and other trade instruments.

While India is clearly encouraging L/C business, it is also using the FTP to ensure that L/Cs are not used to flout export bans placed on certain goods if they are in short supply in the domestic market. Recently, this occurred with the imposed ban on exporting rice.

Traders have sought to bypass export bans by claiming that deals were sealed prior to the effective date of the ban, even if L/C documentation showed that shipping dates fell after the ban became effective. Now the FTP specifically states that if an export or import is subjected to any restriction it will usually be per mitted, provided the shipment is made according to the documentation and via an irrevocable commercial L/C established before the date the restriction was imposed. In order to use such an L/C, the applicant has to register it and contract the authorities within 15 days of the date the restriction was issued.

China

China's resurgence from the global economic downturn has been nothing less than spectacular. Lending growth in the first two weeks of 2010 was reckoned to be around three times higher than it was during the same period last year. Ironically, this has had a mixed impact on the L/C market. In January 2010, reports emerged that L/Cs were in short supply in China, because the authorities were determined to suspend credit to contain the economic boom. Indeed, in the same month, banks across China were ordered to suspend new lending. One such bank, Credit Suisse, told local media that L/Cs had suddenly been withdrawn; other reports talked of L/Cs being withdrawn even when arrangements for them appeared to be solid.

But a major change in China's policy looks set to make a long term impact, at least in the regional L/C environment. Last April, the Chinese government announced the launch of a renminbi trade settlement (RTS) pilot program involving a handful of enterprises in several provinces. The direct settlement system in the Chinese currency aims to reduce foreign exchange risk and conversion costs and envisages the replacement of L/Cs denominated in US dollars with those written in the Chinese currency.

The idea has been received enthusiastically in some quarters. Standard Chartered Bank (SCB) claims it was the first foreign bank to be licensed to participate in the program. Another early participant was OCBC Bank of Malaysia, whose range of services in the program includes the issuance and payment of L/Cs, as well as advising and confirming export L/Cs.

China is now rolling the RTS out across the region and has sent a delegation of officials from the Shanghai Municipal Office of Finance Service, People's Bank of China and State Administration of Foreign Exchange Shanghai to accompany SCB in order to promote the program in Malaysia, Thailand and Singapore. In February, the Bank of China successfully executed its first cross-border RTS for Australia's Auswate Recycling Pty Ltd., one of the bank's most important export clients.

Analysts have expressed concern over aspects of the program, suggesting that problems could arise with claims and liabilities, foreign relationships, exchange management, liquidation arrangements and monetary policies. But the potential benefits are clear. The program helps minimize foreign currency exposure, simplifies the foreign currency transaction process and reduces cross-border transaction costs.

Standard Chartered sees factoring comeback    By Mark Ford
15 April 2010

Standard Chartered is touting its factoring services as an alternative form of trade finance for customers that routinely use letters of credit (L/Cs).

The emerging market specialist bank is one of several international financial institutions offering factoring services in Asia, Africa and the Middle East.

L/C alternative


Standard Chartered's group head of transaction banking, Karen Fawcett, wants customers to look at the bank's L/C alternatives, such as factoring.

She notes that while OECD buyers have largely shifted to open account trading, clients in Asia traditionally use L/Cs, which she says means additional costs.

Fawcett reckons Standard Chartered's factoring arrangements on a portfolio basis may save time and money and would work out to be less expensive than financing trade transactions using conventional credit arrangements.

Resurgence

Factoring was provided by several financial institutions that either failed or were subsumed by other banks in the Asian crisis of 1997.

Other banks in the region now offering factoring services include Citigroup, Deutsche Bank and HSBC.

This article represents the views of the author and not necessarily those of the ICC or any of the other partners in DCPRO TRAINING SERVICES.

Three held on alleged L/C frauds

By Mark Ford
13 April 2010

India's Central Bureau of Investigation (CBI) has arrested the chairman and two directors of a listed company in the Indian city of Ahmedabad for alleged frauds incorporating letters of credit (L/Cs).

The trio allegedly defrauded Andhra Bank of around US$4.7 million by submitting fake and forged documents in order to obtain L/Cs.

Searches

The three men arrested are the chairman and managing director of Vishal Exports Overseas Limited (VEOL), Subash Mehta, and his two sons, Pradeep and Deepak who are both directors of the company.

They were arrested after the CBI searched the company's business premises and the homes of the three men and uncovered various documents utilised in the alleged frauds.

The CBI was acting on a complaint lodged by Andhra Bank.

Allegations

The accused men allegedly managed to access funds and facilities - including L/Cs, bill discounting facilities and other credit facilities - from around 23 banks, between 2004 and 2006.

They managed to access these funds and facilities by using bogus and forged documents to the bank, according to the CBI.

Underlying transactions

The investigators also allege that the accused obtained L/Cs opened in favour of associate companies of VEOL.

However, the CBI says that these L/Cs had no underlying genuine business transactions related to them.

This article represents the views of the author and not necessarily those of the ICC or any of the other partners in DC PRO TRAINING SERVICES

The future of trade

Until 2008, when the music stopped for global trade, the first decade of the twenty-first century could be described as the Roaring Two's. World GDP grew at better than 3.4 per cent per year, with trade in goods and services enjoying 9-12 per cent growth annually. As trade surged, liquidity flooded the international markets, and in the rush to keep pace with rapidly growing trade flows, traditional risk mitigation techniques took a back seat to getting deals done. Participants were confident of anticipating problems and taking steps to remediate issues long before settlement came due.

Banks with limited trade finance experience joined the fun and became international financiers overnight. As was the case in all other asset classes, the money chasing investment opportunities led to reduced due diligence and falling returns. And as returns fell, players became even more aggressive, financing deals with limited knowledge and even less expertise.

Bad times

In mid-2007, real estate values flattened and began to fall in some US and Europe markets. Commodity prices, which had fueled the absolute dollar value surge in global trade, began to flatten too.

By the end of 2008, a massive deleveraging was sucking all liquidity from the markets. Balance sheet strength was not enough to prevent financial institutions from being buffeted by the storms racking global markets. Governments were forced to intervene, using both monetary policy and direct intervention to calm the waters.

The global economy entered its deepest recession since World War II. Global trade ran aground as economic retrenchment took hold and reduced demand for goods and services. Uncertainty about the economic viability of trading partners prevented engagement in any meaningful commerce. Where viable transactions did exist, there was no financing available for them: the primary and secondary markets froze completely and risk appetite was literally at zero.

Although aggressive actions were taken by central banks and multilateral agencies, breaking the cycle would take nearly 15 months. Liquidity was made available in hopes of stimulating minimal levels of trade. Trade finance facilities were made available by local Export Credit Agencies and the financing arms of global multinational organizations. Banks not as dramatically affected by the downturn loaned aggressively - primarily to financial institutions that had been their traditional trade counterparties - not only to help facilitate trade, but to help sustain their own viability.

Recovering

In 2010, year-on-year trade growth is forecast to be 9-10 per cent against an extremely low base, with restoration to pre-crisis levels still projected as a 2012 event. Commodities have stabilized and there are signs of increasing demand and higher prices. Some regions have bounced back from the crisis more quickly than others. Asia fared best because, while overall trade fell, intra-regional trade continued to demonstrate strength. Latin America has borne up well this time, with Brazil demonstrating particular resilience. Turkey has proved a regional standout and functions as a gateway between Europe and the Middle East and Maghreb emerging markets.

Surviving financial institutions have been recapitalized through the markets or direct government intervention. Profitability has been restored in most financial markets, and there is new willingness to lend. Secondary markets are reviving, albeit at only at 60 per cent of pre-crisis levels. The price of risk, which peaked in the first quarter of 2009, has begun to fall and in some markets has returned to pre-crisis levels. Well-capitalized customers continue to have access to the capital and debt markets, but access to capital remains problematical for lower middle market and sub-investment grade borrowers.

In this "back to basics" business environment, highly structured and securitized transactions have declined significantly as accounting rules and investor scrutiny have forced bankers to return to transparent structures. Financing is linked more tightly to the ultimate source of repayment. Documentation standards have been raised to include stronger terms and conditions.

Rebounding

What do we think the future holds? My crystal ball shows global trade rebounding. During the next 12-18 months, trade volumes will likely claw their way back to the levels seen pre-crisis, with accelerated growth continuing in 2013 and beyond. As supply and demand return to their natural balance, markets will resume globalization, and we will probably once again experience the optimism and vibrancy of the early 2000s.

The explosion in global trade over the past decade created globalized, intrinsically linked economies whose interdependencies were as evident in the collapse as they were in growth cycles. These interdependencies cannot be reversed, even if isolationism and protectionism rear their heads in certain countries or regions. We have learned over the years that such restrictions cannot be sustained. Entrepreneurs will find ways to circumvent those barriers in order to make the best product at the best price. Capital flows will continue to seek the best returns, regardless of local legal and regulatory challenges.

Intermediation of country risk had been losing importance pre-crisis and will continue to decline in the post-crisis era. Businesses become more comfortable with cross-border risk as they globalize. While still an impediment to trade, local legal and regulatory regimes are increasingly transparent and can be managed with the appropriate mix of information and people on the ground. Country events, like the political upheaval in Thailand and natural disasters in Pakistan, may temporarily disrupt trade, but alternative channels will develop quickly and efficiently.

The price compression we have seen in the industry will no doubt continue. Customers view plain-vanilla L/C processing as a commodity and will take any competitive bid. With the development of capital markets in emerging economies, suppliers are much less dependent upon the L/C as a credit enhancement for packing loans or pre-export financing.

Letters of credit or other documentary trade products will continue to be utilized when parties involved in a cross-border transaction are new to each other, or when one of the parties is domiciled in a "tough" or highly regulated country. The robust and time-tested body of rules and regulations governing transactions under these instruments will continue to preserve the rights of the various parties and provide consistency in outcomes. Also, as noted in the most recent crisis, the cyclical nature of economies will drive usage depending upon the severity of the downturn.

Crisis as opportunity

"Don't let a perfectly good crisis go to waste" is good guidance in our current circumstances. This recovery is when the future of trade can best be defined.

As they envision the next wave of trade, banks should focus on customers holistically in order to gain understanding of their end-to-end business. This new kind of relationship changes the traditional trade bank's role - "only dealing in documents" - to a new concentration on underlying commercial transactions. From J.P. Morgan's perspective, it means focusing on the customer's supply chain and finding the means to integrate financial and physical activities.

Partnership paradigm

By focusing on the supply chain, we gain visibility to business processes and understand at what point responsibilities begin and end among the parties and when there is contractual or process-driven "commitment" to pay. Looking at commercial risks provides better understanding of when mitigants are required and how they can best be applied as a by-product of the commercial transaction. Success in global trade lies not only with buyers and sellers, but also with servicers and other parties whose coordinated effort is required to deliver value to the end user/consumer. Full knowledge of their interdependencies helps further reduce risk.

The success of integrating finance and commerce is measured by its impact on the parties' bottom line. Optimizing working capital is the end game, and winning means effective management of all aspects of payables, receivables and inventory. Financiers need the ability to leverage the strongest credit in various points of the supply chain to inject liquidity at the right time and in the right place. In the absence of traditional trade instruments, risk mitigation, liquidity and settlement capabilities must be available to the right parties at the right time and at the right price. Value comes to the provider from leveraging technology platforms that support visibility to the transaction through data management. In this new world, trade bankers need to extricate themselves from the paper-handling morass and instead confirm compliance with L/C terms by leveraging supply chain information.

Globalization is now all about outsourcing, alliances and leveraging centers of excellence in ways that are mutually beneficial. Trade banking customers have learned to capitalize on high-quality skilled resources wherever they reside. Banks need to recognize their own weaknesses and partner with firms that help them add value by collaborating to solve problems for the customers they share. In the pre-crisis world, we saw some ill-prepared banks entering trade finance with little more than a fat wallet. In the new world, these participants can provide liquidity in their home markets in conjunction with a facilitator with deeper experience of global markets and supply chains.

Banks must find a niche within their customer's ecosystem. Why shouldn't they become an extension of their customers' business processes and provide value in multiple stages? The customer's payables process increasingly blurs the line between international and domestic settlement. Banks must be able to intermediate both within a single business process. Banks excel at reconciling and controlling processes. Isn't it reasonable to think they can eventually take over the customer's order-to-cash cycle from shipment through collection and invest the resulting proceeds? This is the thinking of the futurists who are focused on flourishing in the future of trade. And the future, as we would probably all agree, starts tomorrow.

Michael Quinn is Managing Director, J.P. Morgan Global Trade. His e-mail is [email protected]

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When China announced the pilot Renminbi (RMB) Trade Settlement Scheme (RTSS) in April 2009, it cleared the way for yuan-denominated trade settlements between certain enterprises on the Chinese mainland and counterparties in countries in the Association of South East Asian Nations (ASEAN) as well as Hong Kong and Macau. Last year the scheme was expanded so that trading partners across the world could participate in yuan-denominated letters of credit and other trade transactions.

 

The impacts of the RTSS will be substantial, challenging the US dollar's domination of world trade and establishing the yuan alongside the dollar, euro and yen as a key currency in foreign exchange markets. Whilst there is huge enthusiasm for RMB settlements, bankers canvassed by DCInsight say the current value of this business remains low because of the limited number of Chinese firms participating in the scheme and bureaucratic procedures in the RTSS mechanisms.

Early days

Demand is clearly strong from exporters and importers of goods to and from China for trade finance transacted in the Chinese currency. "Chinese buyers are increasingly telling our exporters that they want to pay for purchases using yuan-denominated L/Cs to mitigate exchange rate risk," one London-based banker told DCInsight. "This is particularly the case with exports where the parties need to agree a stable price over the medium - or long-term," he added.

Another banker said he expected to see as much as 95 per cent of all of China's exports to be covered by the scheme in five years. During the first year of the scheme, only around 0.4 per cent of China's exports were covered by the pilot scheme.

The scope of the original pilot scheme was not large - covering only trades between 450 specified Chinese enterprises in five cities. Only trades between Shanghai, Shenzhen, Guangzhou, Zhuhai and Dongguan with Hong Kong and Macau, as well as transactions between Yunnan and Guangxi with ASEAN countries were allowed.

Nevertheless, the scheme marked a step in China's long-term strategy towards globalizing its currency and reducing the dominant influence of the dollar in world markets. China's current role in foreign exchange markets is not commensurate with the size of its economy and export capacity - due mainly to limitations on the yuan's use in international trade and restrictions imposed on its supply and convertibility.

China has yet to build a financial services infrastructure to truly represent a globalized Chinese currency, and there has been some speculation over the roles of Hong Kong and Shanghai in this respect.

China's 12th five-year plan announced in March 2011 specified that fast-growing financial hub Shanghai will focus on onshore financing activities, while Hong Kong will develop offshore yuan business with help from Shanghai.

World opening

In June 2010, the RTSS was opened up to the rest of the world when enterprises in 20 Chinese mainland provinces and cities were admitted into the scheme.

Nonetheless, the scheme is limited. Chinese companies receiving payments must still be on the list of Mainland Designated Enterprises (MDEs) and validate with their local bank that the transaction conforms to requirements specified by the People's Bank of China.

Trade services offered by banks typically include L/Cs, including standby L/Cs, documentary collections and open account trading. However, RMB transactions are limited to the amount of an actual trade transaction, and payment to MDEs has to be made directly.

International banks such as HSBC, JPMorgan and Standard Chartered have embraced the scheme, typically by promoting trade services in the Chinese currency and launching RMB-denominated current accounts. It is now possible to find RMB-denominated L/Cs arranged by banks in countries including Turkey, South Africa and Russia, as well as in many European, North American and Australasian countries.

Sometimes it is up to countries to make the first move so that L/Cs can be RMB-denominated. In February 2011, Nigeria said it had included the Chinese yuan on the limited list of currencies it allows for trade settlement in the foreign exchange market, thereby enabling Nigerian banks to denominate L/Cs in the Chinese currency.

The HSBC Group reckons to be at the forefront of banks to introduce RMB capabilities and products, having now rolled these out across much of its worldwide network. It claims several RMB firsts - as the first international bank to complete RMB-denominated trade settlements across six continents, the first foreign bank to issue RMB bonds in Hong Kong and the first international bank to offer RMB current account and cheque services.

Growth anticipated

A banker at HSBC Bank Canada, which completed its first Canadian international RMB trade settlement transaction in January 2011, said he expected rapid growth in trade yuan-denominated settlement transactions.

Executive vice president for commercial banking at HSBC Bank Canada, Mark Watkinson is optimistic about the future too. "China's continued, explosive growth in the world trade market will likely result in a significant increase in Chinese imports and exports being settled in RMB," he says.

A London-based banker told DCInsight that he expects to see RMB trade finance growing steadily over the coming months, after which he anticipates stronger growth over the next five or six years as China's currency liberalization plans unfold and impact on world markets.

Some analysts say RMB cross-border transactions will show their strongest increase in the ASEAN region over the next few years, in line with strong growth anticipated in Sino-ASEAN trade. Estimates vary, but one analyst reckons that in five years, yuan-denominated transactions may account for 50 per cent of China's USD 200 billion annual trade with Hong Kong and 30 per cent of the USD 250 billion of trade between China and ASEAN countries.

Pros and cons

The perceived benefits of RMB financing include reduced dependence on the dollar, on which almost all trade flows in the ASEAN region are currently based. There are widespread concerns in Asia about the potentially negative impacts of rising US fiscal deficits and government indebtedness on the long-term stability of the US dollar.

Supporters of reduced dependence in the region on the dollar include secretary-general of the UN Conference on Trade and Development (UNCTAD), Supachai Panitchpakdi. He says Asian countries should increasingly use local currencies in inter-regional trade settlements to avoid currency disturbances stemming from US monetary policies. As well as encouraging more RMB account settlement, he argues for more use of the Indonesian rupiah or the South Korean won in regional inter-trading.

Other benefits of the RMB scheme include the yuan's lower volatility since the global financial crisis compared with the dollar, euro and yen. Yuan-denominated transactions could also help counterparties save costs, since a stable currency should result in reduced currency conversion and hedging costs when traders will no longer need to hold US dollars

But enthusiasm in these early days of RMB trade financing is tempered by the inevitable teething problems of a new system. One banker told DCInsight that the validation process MDEs need to undertake in the scheme means it can take several days to complete a transaction, although she is hopeful that transactions will be executed more quickly once all the parties grow accustomed to the procedures.

Another point made by several bankers is that for the moment, the scheme is limited to too few Chinese MDEs and the that RMB will only take off in a big way when the possibilities for writing yuan-denominated business are extended across China's increasingly vibrant trading base.

 

URDG, forfaiting rules and an Incoterms revision

Now that the revision of ICC's Uniform Rules for Demand Guarantees has been approved, ICC's attention has turned to the development of two other sets of rules.

 In May 2004, two officers of the International Forfaiting Association (IFA) made a presentation to the ICC Banking Commission regarding the work of the IFA and their forfaiting Guidelines for the Secondary Market. They expressed an interest in the IFA working with the ICC on the development of forfaiting rules.

Over the next four years the IFA and the ICC Banking Commission maintained contact, and additional presentations were given to both organizations about possibly working together. At the spring 2008 meeting of the Banking Commission, a project and Drafting Group were authorized. The Group is composed of ten members - five from the IFA and five from the Banking Commission, with members representing varying geographies, professions and business backgrounds.

The first set of drafting meetings were held in conjunction with the September IFA annual conference, and the second in conjunction with the ICC Banking Commission November meeting.

Substantial progress had been made on the project in a very brief time. For example, there was unanimous agreement on the mission: draft a set of rules that will gain acceptance in the both the primary and secondary markets and therefore facilitate the global growth of forfaiting financing; the name Uniform Rules for Forfaiting (URF); the drafting language (English) and writing style (similar to UCP); the use of the IFA existing publications (now three in number) as the basis for the new rules; the target audience (clients and bankers new to the business); a framework with an article structure similar to the UCP (application of the rules, opportunity for waiver or variance, definitions, interpretations, etc.); and a focus on driving to a conclusion with a set of rules that are ready for the market rather than forcing the Drafting Group to a pre-determined calendar deadline.

Some of the challenges facing the Drafting Group include focusing on keeping the writing style short and using words which easily translate both the words and concepts into other languages and business practices; maintaining an operational maintaining an operational drafting style rather than a legalistic approach; keeping the URF short enough to be useful yet comprehensive enough to cover the subject while maintaining the focus on a single set of rules covering both the primary and secondary markets (two very different markets).

Among the issues raised early in the drafting discussion was the role of representations and warranties - those given by the customer to the primary forfaiter, and whether they continue through the life of the transaction to all future holders of the transaction.

The Incoterms revision, well underway, is being developed by ICC's Commission on Commercial Law and Practice. A Drafting Group consisting of representatives from seven countries was established and met five times in 2009. Two drafts have already been submitted for comments by ICC national committees, drawing extensive comments from 25 of them. Replies will be analyzed at another meeting in Prague in March 2010, where ideally a final draft will be prepared for consideration at the May meeting of ICC's Commercial Law and Practice Commission.

A number of issues remain to be decided, but certain features can be predicted with reasonable certainty:

- The title will definitely be Incoterms 2010. Several other titles were proposed to avoid the expectation of mandatory tenyear revisions, but a decision was made to proceed with Incoterms 2010;

- There will very likely be fewer than the 13 Incoterms in Incoterms 2000; as many as three terms may be dropped, and another one added;

- New features will make Incoterms 2010 more user-friendly than previous versions;

- As mentioned in our previous report, Incoterms 2010 will be applicable to domes tic as well as international transactions; and

- The revision may well be launched in autumn 2010.

 

BILL OF LADING

 House Bill of lading (HBL) is another name for a "bill of lading" issued by a forwarder. A typical HBL is issued by a forwarder as agent, and incorporates the terms and conditions of a national forwarders association. It gives particulars of the transport arrangements the forwarder has made, much as an ocean bill of lading does, but does not contain a promise by the forwarder to deliver at destination. A party receiving an HBL could well be confused by its similarities with an ocean bill of lading, and so unaware of this omission.

Forwarders do not have possession of goods covered by the HBL, which are under the control of the actual carrier. Forwarders may not even have a right of immediate possession against a carrier who is exercising a right to retain the goods until it receives additional amounts, such as container demurrage.

As possession of an HBL is not an assured means of controlling goods, the value of the document to a bank that has paid under a letter of credit is reduced. Banks generally prefer an ocean bill of lading as the appropriate transport document. Article 30 of UCP 500, which governs letters of credit, rejects typical HBLs as adequate tender.

This rejection is qualified by the words of Article 30 in UCP 500 that state "unless otherwise authorized in the credit". Theoretically a vendor of goods could prevail on its purchaser to arrange for the issue of a letter of credit that accepts an HBL. If the purchaser, who is ultimately responsible to repay monies advanced under a letter of credit, is a good credit risk, its bank will be less likely to insist on tender of an ocean bill of lading.

If practice, forwarders proved generally unwilling to prompt their customers to have a letter of credit accept tender of an HBL. Equally, few customers were prepared to press their purchasers for this concession.

Assuming that there is a letter of credit issued, does the typical HBL add value to the transaction? It is not a carrier document and so not the most suited document for a transaction where negotiability is the key thing. Unless specifically authorized, a bank issuing the letter of credit ought to reject it. So it adds little value to the transaction, and, because it may cause confusion and delay, should not be issued.

Still some forwarders are attached to house bills of lading, and continue to use them despite problems they can cause. One consequence of the continued use of the HBL is that the old prejudices against forwarder documents persist, to the possible detriment of FIATA documents such as the FBL.

FIATA has proposed that forwarders use the FIATA Certificate of Transport (FCT) instead of house bills of lading. Judging by the number of FCTs issued, its efforts have so far been without great commercial success. The FCT is a relatively unknown document, and banks continue to prefer an ocean bill of lading, a preference that is naturally adopted by their customers.                  ▄

 


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UCP 600 and Banco Santander
 
A recent court case and URDG in the Arab world

 


Extracted from: DCInsight Vol. 17 No.2 April - June 2011

 

Suretyship: guarantee or indemnity

By Roger Fayers

"What's in a name?" Shakespeare wrote, "That which we call a rose by any other name would smell as sweet (1), but he surely didn't have in mind English law on suretyship. This, as recently described by the judge in Vossloh Aktiengesellschaft v Alpha Trains (UK) Ltd(2), is an area bedevilled by imprecise terminology in which it is all too easy to become confused by the words used or the labels given by the parties in suretyship undertakings they have entered into.

 

In former times it seems it was simpler to differentiate between two main categories of suretyship - the guarantee and the indemnity. Not so today. Over time parties have come to negotiate ever more complex commercial contracts with accompanying security undertakings that contain clauses, often couched in archaic language, modifying the respective rights and liabilities. It is not unusual nowadays to find the term "guarantee" used as a label to describe what is in reality an indemnity, and vice versa.

Accordingly, a field of law exists in England that covers a wide spectrum of contractual possibilities. A consequence is that the parties to an agreement - and in the last resort, the courts - now increasingly face and have to interpret provisions that point (often ambiguously) towards both primary and secondary obligations. Just where on the spectrum a particular agreement may fall becomes, therefore, a matter of "nice judgment" calling for the detailed examination of wording (in Vossloh six out of the guarantee's twelve clauses) in order to determine its indication of a primary or a secondary obligation. This task is not helped by the fact that provisions often overlap and duplicate themselves.

The Vossloh case

So, to the Vossloh case. Briefly, a Vossloh subsidiary (VL) entered into a contract to manufacture and supply trains to Alpha in respect of which Vossloh was required to give a parent company guarantee (the VAG guarantee). Alpha complained of various defects in the engines and gearboxes in some of the trains supplied by VL and, at the same time, it made a demand under the VAG guarantee. The contract dispute is the subject of separate court proceedings. The present action concerned the basis on which VAG as guarantor could be required to pay under its guarantee.

Suretyship: the variants

Since the term "suretyship"' can embrace a variety of undertakings, perhaps the best way to explain it is by describing the types of instrument under which VAG could have incurred a liability towards Alpha.

First, the VAG guarantee could have been a guarantee in the strict sense(3). Here, VAG, as surety (or guarantor) would have promised Alpha to be responsible for the due performance of VL's existing or future obligations towards Alpha under the contract if VL failed to perform any of them.

An essential distinguishing feature of this type is that the liability of VAG would have been ancillary (or secondary) to that of VL, which would remain primarily liable to Alpha. There would be no liability on VAG unless and until VL had failed to perform its obligations. What is called the "principle of co-extensiveness" would ensure that VAG was only liable to Alpha to the same extent that VL was liable to Alpha. For example, there could be no liability on VAG if the contract between VL and Alpha was void or unenforceable, or if the obligation of VL under that contract ceased to exist.

A variant of this type is the so-called "see to it" guarantee. In such a case VAG would have undertaken that VL would carry out its contract and that VAG would answer for VL's default. If for any reason VL did then fail to perform as required by its contract with Alpha, VL would not only break its own contract, but it would also put VAG in breach of its agreement with Alpha, thereby entitling Alpha to sue VAG for damages. These damages would be for the loss suffered by Alpha due to VL having failed to do what VAG undertook to Alpha that VL would do (i.e., supply trains with workable engines and gearboxes) (4)

In contrast, VAG's agreement could have been a contract of indemnity. In this case, VAG's agreement would have been by way of a security to Alpha for the performance by VL, its essential distinguishing feature being that (unlike under a guarantee) a primary liability would fall upon VAG wholly independent of any liability that may arise as between VL and Alpha. The fact of VAG's obligation to indemnify Alpha being primary and independent would have the effect that the principle of co-extensiveness would not apply. The indemnity would not only shift the burden of VL's insolvency on to VAG, but it would also safeguard Alpha against the possibility that its contract with VL was void or unenforceable. It would also prevent the discharge of VL or any variation or compromise of Alpha's claims against VL from necessarily affecting VAG's liability to Alpha. Otherwise, the rights and duties of the parties to a contract of indemnity are generally the same as those of the parties to a contract of guarantee.

Another variant needs to be mentioned. This has been described as "in essence a particularly stringent contract of indemnity". It is the so-called "performance bond" - sometimes known as a "demand bond" or "demand guarantee" or even as a "first demand guarantee" or "demand bond". If this were its agreement, VAG's liability would be to pay a specified sum of money to Alpha on the occurrence of a stated event, namely, the non-fulfilment by VL of a contractual obligation to Alpha. The wording of the VAG guarantee could result in VAG's liability arising on the mere demand by Alpha (even though it may be evident that VL was not in default or even if Alpha itself was in default under its contract with VL). Alternatively, the VAG guarantee wording could indicate that in addition to Alpha's demand, it was necessary that Alpha demonstrate the existence of a breach or failure of some obligation by VL.

What did VAG undertake?

Whether a particular agreement is of the one kind or the other or, indeed, a combination of all of them, is a matter of construction. Accordingly, whether the trigger for VAG's obligation was by Alpha's demand alone or by one accompanied by specified documents, or whether it was a guarantee (strictly so called) conditional on proof by Alpha of default by VL could only be answered by looking into the actual wording of the VAG guarantee itself. This involved "construing the instrument in its factual and contractual context having regard to its commercial purpose", a task which the court approaches "by looking at it as a whole without any preconception as to what it is".

Not surprisingly, the parties differed on what triggered liability. VAG argued that its obligation was only triggered by proof (whether by admission or the decision of a court) of a breach of contract by VL. Alpha, on the other hand, contended the trigger to be its demand alone.

The court's decision

The court's approach was as follows.

(a) The decision of the court of appeal in Marubeni Hong Kong v Government of Mongolia (5) established that in cases where undertakings are given not by a bank and not in a banking context there is a strong presumption that the payment obligation does not constitute a "demand bond";

(b) VAG was not a bank;

(c) accordingly, the question was whether there was clear language in the operative clauses of the VAG guarantee or in its contractual context to rebut this presumption;

(d) viewing the instrument as a whole, the court did not consider that the presumption against construing it as a demand bond had been rebutted; and

(e) a strict approach was to be adopted to the wording of a "conclusive evidence" clause. The particular provision in the VAG guarantee was not to be read as having the effect of turning VAG's undertaking into one analogous to a bond payable simply on demand.

In the result, the court held that liability under the VAG guarantee was premised upon there being a failure of performance of some underlying obligation by VL, the intention of the guarantee being to make good the loss thereby suffered. The guarantee was premised upon the establishment of that loss by Alpha.

Roger Fayers' e-mail is [email protected]

1 Romeo and Juliet, Act 1, scene 2.
2 [2010] EWHC 2443 (Ch).
3 The need to add these four words or to describe it as a classic guarantee illustrates how things have changed.
4 See Moschi v Lep Air Services Ltd [1973] AC 331.
5 [2005] 2 Lloyds Rep. 255.

 

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