Introduction
and Background
Banks have discounted Documentary
Letters of Credit (“Credits”) for many decades, following the first set of
uniform rules published by the ICC
(International Chamber of Commerce) in 1933. Yet when the infamous and much quoted
case of Banco Santander SA vs Banque Paribas was heard before the English courts in 1999, it raised serious concerns
amongst trade finance practitioners. Many articles were written at the time,
resulting in one of the most important changes in the updated ICC Uniform
Customs and Practice for Documentary Credits (‘UCP 600’)
regarding the treatment of deferred letters of credit.
The ICC was compelled to ensure
that there was consistency between regions on a point so critical to the survival of secondary market trading. A
new Article 12(b) was introduced into UCP 600 as follows: “By nominating a bank to accept a draft or incur a deferred payment
undertaking, an Issuing Bank authorizes that Nominated Bank to prepay or
purchase a draft accepted or a deferred payment undertaking incurred by that Nominated
Bank'' thereby facilitating the fundamental business need for the discounting of deferred
credits.
The provision applies where the Nominated
Bank which has incurred a deferred payment undertaking discounts its obligation
before maturity and subsequently fraud is discovered. The effect is that the Issuing
Bank is not relieved of its obligation to reimburse the Nominated Bank, even if
the fraud comes to light before maturity. The terms Issuing Bank and Confirming
Bank are used interchangeably in this article mirroring the economic effect of the undertakings
in Articles 7 and 8 of UCP 600 relating to Issuing Banks and Confirming Banks respectively.
The stipulations in Articles 7, 8
and 12 of UCP600 have established the independent rights given to a Nominated
Bank to incur a deferred payment undertaking which includes the authorization
to a Nominated Bank to prepay. The right to get reimbursed is not affected by
the action of such Nominated Bank to actually prepay or discount such letter of
credit.
Whilst this treatment of deferred
payment credits addresses the main issue raised in Santander, the question as to whether Third Party Banks or forfaiters
which further discount such Credits get the same protection as the Nominated Bank
has not been resolved or dealt with by the changes made in UCP600.
What is the position, for
example, of the Third Party Bank/forfaiter which gets an assignment of proceeds
from a Nominated Bank or directly from the beneficiary? Furthermore, if an Issuing
Bank gives an undertaking of payment at maturity to a Third Party Bank, and
such Third Party Bank then assigns proceeds to another Bank, does this give the
same rights to the Third Party Bank as those of the Nominated Bank? What can a Nominated/presenting
Bank do if the Issuing Bank refuses to amend reimbursement instructions and
insists that its obligations are limited to those set out in UCP600?
Most of the issues in this area
relate to the vulnerability of assignees to defects in the rights being ''sold'' by
the assignor. Before discussing these issues it is worth noting that these
problems can be avoided by ensuring that the financial institution intending to discount a deferred payment credit
is appointed as the Nominated Bank,
either by having the Credit available with them or alternatively, available
with any Bank. Needless to say however, this is not always possible.
Under English law and many other
common law legal systems, the basic starting point is that an assignee cannot obtain
a better title than his assignor. This is sometimes known as taking “subject to
equities” that is, rights which other parties have against the assignor and
which the assignee must consequently respect as they existed on or before the
date of assignment. Accrued rights to set-off against the transferred debt by
the obligor of that debt are one example of such rights. In such circumstances,
it would be unfair for the debtor to lose its rights simply because there had
been a change of creditor.
It is perfectly possible for a
debtor, say an Issuing Bank, to agree that it will pay an assignee regardless of
any defects in the rights which have been acquired from the assignor. In the
case of letters of credit, Article 39 of UCP 600 allows for proceeds to be
assigned to a Third Party Bank. Such an assignment is, of course, indispensable
when a Third Party Bank buys the right to receive payment from either a Nominated
Bank or a beneficiary. Such an assignment does not, in and of itself however,
cure or resolve the issues relating to defects or adverse claims affecting the
assignor’s rights explained above but these
can be overcome with a suitably worded acceptance of the notice of assignment by
the Issuing Bank. Obtaining an acceptance of assignment of proceeds is, and has
been for some time, standard forfaiting practice but care needs to be taken as
whilst UCP 600 makes it clear that a beneficiary may assign proceeds, the
Issuing Bank is under no obligation to either accept such requests or to
acknowledge them. This has become more of an issue with some Banks becoming
increasingly wary of accepting such requests from non customers, or in some
circumstances where it is claimed that the assignment will result in a conflict with local law. Needless to say this is a barrier to the
prepaying/discounting by third party institutions and is therefore to be
discouraged.
It is of course at the discretion
of every Bank to take into consideration other mitigants and specifics of the
transaction that may well allow them to discount a Credit.
It is good practice however that
in all cases any Third Party Bank/forfaiter discounting a Credit advises the
Nominated Bank of its intention to do so.
Apart from ensuring that there
has been an assignment of proceeds under Article 39 of UCP 600, the assigning Nominated
Bank or beneficiary must ensure that the assignment is valid and has been created before the SWIFT advising
such assignment is sent to the Issuing Bank.
Whilst a notice of assignment and
acceptance should be obtained in all cases where proceeds due under a Credit
are assigned to a Third Party Bank, an endorsement of a draft can in many legal
systems provide similar protection under national legislation e.g. under the English
Bills of Exchange Act 1882 where an endorsee can benefit from the protection afforded
to holders in due course. It is
understood by all parties that Issuing Banks can only pay Third Party Banks
subject to the satisfaction of their KYC procedures. Whilst many Issuing Banks
do not charge assignment fees to encourage trading of their own name, this is
not always the case. Where fees are charged it is a matter of commercial
negotiation as to the amount that the Issuing Bank will charge for such
assignment although one hopes that these are restricted to KYC expenses and
changes in payment instructions.
In addition to the Issuing Bank
carrying out KYC on the bank it will pay at maturity, it is also practice for the Third Party Bank (usually
not a party to the Credit) to carry out due diligence in relation to the
underlying transaction and counterparties. Although this may be no easy task, Uniform Rules for Forfaiting (URF 800) ,
Introduction to the Primary Forfaiting Market and The Forfaiting Money Laundering and KYC checks all published by ITFA and
available to its members, give guidance on this issue to Third Party Banks wanting
to discount Credits. The Rules and Guidelines take into consideration other measures
that banks may take to protect themselves (at least to some extent) on issues
that relate to the underlying trade and its counterparties, specifically as
they may not be a party to the Credit. It is of course imperative that such an
analysis takes place before the discounting of a transaction. Whilst for
established clients this process may be one of routine, tools exist to
facilitate detailed analysis of the transaction, for example to track vessels
and Bills of Lading. The Third Party Bank should insist that although the
transaction is being discounted on a ''without recourse basis'', there is an
ability to retain recourse in the event of
a breach of any representation and warranty that such Bank may have on
the Bank or counterparty selling the asset/transaction.
The other key question is that
when a beneficiary presents documents through an Advising Bank (not the Nominated
Bank) under the Credit, and the acceptance of documents is sent to such Advising
Bank confirming a payment undertaking, could that Advising bank discount the
proceeds under the Credit and seek the same remedy as that of a Nominated Bank
under UCP 600? In our opinion when an Issuing Bank gives
a reimbursement undertaking to a presenting bank, that presenting bank is effectively
authorized to then discount a deferred payment undertaking. It is advisable though
that such presenting bank should still advise the Issuing Bank of its intention
to discount the proceeds under the Credit before doing so.
Whilst URF 800 allows for
specific provisions under Article 4a, 13e and optional clauses to limit the
liability of each party, such representations and warranties are as strong as
the party you are dealing with. Therefore, the due diligence process including
the analysis of the balance sheet of your counterparty to whom you will
discount on a ''without recourse'' basis cannot be undermined. For a Third Party Bank to mitigate the risk
of fraud that could happen from the time the documentation is accepted to
maturity, the Third Party Bank should insist on having recourse to the Seller
whether the Nominated Bank or otherwise together with other representations and warranties set out in
the agreement between the two parties.
Disclaimer: This information does not constitute legal advice and is for education purposes only. You should not rely on this opinion as an alternative to seeking legal advice.
