Sunday, 11 September 2016

TECHNICAL PAPER - ASSIGNMENT OF PROCEEDS UNDER LETTERS OF CREDIT - UCP600 by Lorna Pillow, Senior Vice President, London Forfaiting Company Limited, ITFA Board Member

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 [1] 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) [2], 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 [3] 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.

[1] Note than where the assignor is a Nominated Bank it should not be subject to any defences to payment based on fraud given the changes to UCP mentioned above and so the rights it passes on to an assignee should be similarly unaffected.
[2] Uniform Rules for Forfaiting (URF) 800 is the first standard set of rules for forfaiting transactions by ICC in partnership with International Trade and Forfaiting Association (ITFA).
[3] Refer to Uniform Rules for Forfaiting (URF 800) and Introduction to The Primary Forfaiting Market 

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