SOME RANDOM THOUGHTS ON THE UCP[1]

Rupnarayan Bose[2]

 1. Introduction

Often I had wished that I were a fly on the wall, had a voice recorder in place to record the deliberations, or could browse through the background papers and notes while the first ever UCP was being drawn up nearly 80 years ago. Tapping into the minds of the first ever drafting group could have been a revealing experience. For, very recently, while trying to understand the true meaning of the term “negotiation” and a few other provisions of the UCP, the question that I repeatedly asked myself was, “Does the UCP have its roots in the laws of contract?” For, there were certain inescapable similarities between the articles of the UCP and the laws of contract. I am not a member of the legal profession, neither qualified in matters of law. Yet, even to a layman like me, the similarities became so compelling that I decided to put my thoughts on paper. My initial effort resulted in a paper published in DC Insight^[3]. I based that paper on the Indian Contract Act, 1872. However, since the Indian Contract Act (ICA) was formulated by the British, I looked for the original English Act to use it in my analysis. To my surprise I learned that, even today, there is no English law equivalent to the Indian Contract Act 1872 (ICA).

The ICA appears to be basically a codification of the English Common Law (the unwritten law which consist of judge-made decisions and established commercial practices) as it was in the 1870's and still is to a large extent today. In contrast, the UCP is a compilation of the “best practices” in the international letters of credit operations, a specific set of rules especially designed for, and tailored to the specific requirements of, documentary credit operations. Having said that, the English contract law and its derivative Commonwealth variations (Australia, New Zealand, India and so on) could, in all possibility, have played an influential role in the drafting of the first UCP – possibly due to the prominence of the London banking market in international trade. That flavour largely remains till date. There are a number of principles of law in India and England that would appear to be easy to reconcile with the principles in the UCP. To this, we may add the United Nations Convention on Contracts for the International Sale of Goods (CISG)[4]. But there are also instances where the UCP takes a path that could be considered at variance with the English law. This paper seeks to compare and contrast selected provisions of UCP 600 with certain sections of primarily the ICA (plus selections from Part II of the CISG titled “Formation of the contract”) and, in the process, make an attempt to analyse what exactly is the UCP all about.

 2. Comparison with the laws of contract

Let us begin with extracts from Section 2 of the ICA titled “Interpretation clause” that are of immediate interest to us:

     (i) Sub-section 2(a): “When one person signifies to another his willingness to do or to abstain from doing anything with a view to obtaining the assent of that other to such act or abstinence, he is said to make a proposal.”

    (ii) Section 9: “In so far as the proposal or acceptance of any promise is made in words, the promise is said to be express….”.

    (iii) Sub-section 2(c): “The person making the proposal is called the "promisor” and the person accepting the proposal is called the “promisee".

   (iv) Sub-section 2(b): “When the person to whom the proposal is made signifies his assent thereto, the proposal is said to be accepted. A proposal, when accepted, becomes a promise.”

    (v) Sub-section 2(e): “Every promise and every set of promises, forming the consideration for each other, is an agreement.”

   (vi)  Sub-section 2(h): “An agreement enforceable by law is a contract.”

Article 14(1), Part II (titled Formation of the contract) of the CISG states,

“A proposal for concluding a contract addressed to one or more specific persons constitutes an offer if it is sufficiently definite and indicates the intention of the offeror to be bound in case of acceptance….”

 3. Issue of a letter of credit

Superimposing the operation of a letter of credit on the sub-sections of the ICA as also the CISG quoted above, the issuing bank could easily be termed as the ‘proposer’, the ‘promisor’ or the ‘offeror”. The issuing bank (the promisor’ or ‘offeror’) makes a written (express) offer – not to the world at large, but to a specific party, the beneficiary – requiring certain acts to be performed. The details are specified in a written document called the Documentary Credit or the Letter of Credit (LC).

The ‘promisee’ (the beneficiary) is required to indicate ‘acceptance’ of the ‘offer’ by complying with the terms and conditions of the ‘offer’ (the LC). When accepted by the beneficiary to whom the promise is made, there is a mutual set of promises; an ‘agreement’ or a contract is in place.

The same concept could apply to an offer for purchase or sale, a purchase order, or a contract between a buyer and a seller that usually precedes a trade transaction.

 4. Communication of a credit

When precisely is an offer supposed to have been made? Section 4 of the ICA, titled Communication when complete, states, “The communication of a proposal is complete when it comes to the knowledge of the person to whom it is made.” The communication as a whole is complete, yes, but specifically speaking, when is it complete as against the proposer, and later, against the acceptor? For a clear answer to this question we have to look at the illustrations to Section 4. One of these goes as follows,”

“A revokes his proposal by telegram. The revocation is complete as against A when the telegram is despatched (emphasis added). It is complete as against B when B receives it. B revokes his acceptance by telegram. B's revocation is complete as against B when the telegram is despatched, and as against A when it reaches him.”[5]

We find a reflection of the above in Article 7(b) of UCP 600, which states, “An issuing bank is irrevocably bound to honour as of the time it issues the credit.” The term “issues” means the time when the LC is actually despatched, or leaves the effective control of the issuing bank. It is the same with confirmation (UCP sub-article 8.b) or amendments to LCs (sub-article 10.b).

 5. Revocation

So far as revocation is concerned, the ICA differs from the UCP. Section 5 of the ICA states,

“Revocation of proposals and acceptances –

§ A proposal may be revoked at any time before the communication of its acceptance is complete as against the proposer, but not afterwards.

§ An acceptance may be revoked at any time before the communication of the acceptance is complete as against the acceptor, but not afterwards.

Note carefully the expression, “…communication of the acceptance is complete .....”.

The provisions CISG reflects a somewhat similar approach. Article 15(2) of the CISG states that, “An offer, even if it is irrevocable, may be withdrawn if the withdrawal reaches the offeree before or at the same time as the offer (emphasis added)”. Article 17 on the revocation of an “irrevocable” offer, stipulates, “An offer, even if it is irrevocable, is terminated when a rejection reaches the offeror (emphasis added).” Continuing with the same theme, we read in Article 16(1) of the CISG, “Until a contract is concluded an offer may be revoked if the revocation reaches the offeree before he has dispatched an acceptance.”

The section of the CISG that we are really interested in, that applies to the irrevocability of an LC, appears immediately afterwards, under Article 16(2), as follows:

“However, an offer cannot be revoked:

(a) if it indicates, whether by stating a fixed time for acceptance or otherwise, that it is irrevocable; or

(b) if it was reasonable for the offeree to rely on the offer as being irrevocable and the offeree has acted in reliance on the offer.”

An LC is in agreement with Article 16(2) of the CISG on both counts. It is an irrevocable instrument, and it indicates “… fixed time for acceptance [performance] or otherwise”, namely, last dates for shipment and for the presentation of documents. Sub-section (b) of Article 16 quoted immediately above can also be taken as given.

Continuing with our analysis, Article 7(b) stipulates that the issuing bank is irrevocably bound to honour its own LC from the moment it is issued. Further, just like any valid agreement or contract, it can be modified or revoked provided all parties to the contract or agreement agree to it, not otherwise (Article 10.a). “A contract may be modified or terminated by the mere agreement of the parties (Article 29(1) of the CISG).”

Curiously, while irrevocability is one of the greatest strengths of documentary credits, the term has not been specifically defined anywhere in UCP 600.

 6. Performance under a credit

In the same way that a person cannot be compelled to accept an offer, we know that an LC too cannot compel the beneficiary to perform under the credit. If, however, the beneficiary decides to accept the offer, he must signify acceptance in the manner specified in the offer (document). There are various ways to do so. Section 3 of the ICA, under Communication, acceptance and revocation of proposals, states as follows:

“The communication of proposals, the acceptance of proposals, and the revocation of proposals and acceptances, respectively, are deemed to be made by any act or omission of the party proposing, accepting or revoking by which he intends to communicate such proposal acceptance or revocation, or which has the effect of communicating it.”

Section 8 of the ICA states, “Performance of the conditions of a proposal, or the acceptance of any consideration for a reciprocal promise which may be offered with a proposal, is an acceptance of the proposal.” Similarly, Article 18(1) of the CISG states, “A statement made by or other conduct of the offeree indicating assent to an offer is an acceptance. Silence or inactivity does not in itself amount to acceptance (emphasis added).”

Thus, if the beneficiary makes a presentation to a nominated bank in accordance with the terms of the credit, it signifies “acceptance” of the offer from the issuing bank. By making a complying presentation, “one person [the beneficiary] signifies to another [the issuing bank] his willingness to do ….. anything with a view to obtaining the assent [viz., commitment to honour, to pay, the confirming bank to negotiate without recourse] of that other to such act.” (Sub-section 2(a) of the ICA.)

In documentary credit operations, the complying presentation of documents which, in effect, is the act of “acceptance” of the issuing bank’s proposal, reflects the order defined by Section 52 of the ICA (“Order of performance of reciprocal promises”):

“Where the order in which reciprocal promises are to be performed is expressly fixed by the contract, they shall be performed in that order; and, where the order is not expressly fixed by the contract, they shall be performed in that order which the nature of the transaction requires.”

Naturally so!

Thereafter, once the beneficiary, by his act of performance as stipulated in the credit, has indicated his acceptance of the issuing bank’s “proposal”, we have a “set of promises forming the consideration for each other”. Against the “promise” (performance, compliance) of the beneficiary, the issuing bank is, perforce, obligated to keep its part of the contract, which is to honour or pay. Article 7 of UCP 600, defining the commitment and obligations of the issuing bank, is therefore the core of the UCP and documentary credit operations.

 7. Complying presentation

Recall that, according to sub-section 2(e) of the ICA, after a presentation has been made, there now exists an agreement, i.e. a “set of promises, forming the consideration for each other…”. This set of promises, coming into being through the submission of documents in terms of the credit (the “offer”, the issuing bank’s “promise”), indicates the beneficiary’s acceptance of the offer.

This acceptance (presentation of documents) must follow certain rules. Sub-section 7(1) of the ICA states that, “In order to convert a proposal into a promise, the acceptance must, first, be absolute and unqualified (emphasis added).” This brings to our mind the definition of a “complying presentation” (Article 2) as also sub-article 14(a) of UCP 600. Sub-section 7(2) of the ICA defines the manner in which such acceptance (viz., compliance with the terms of the credit) should be carried out. The acceptance by the beneficiary should be “expressed in some usual and reasonable manner^[6], unless the proposal prescribes the manner in which it is to be accepted.” In the case of documentary credits, an LC does stipulate “the manner in which it is to be accepted” (refer to Article 6 of UCP 600). Presentations must strictly comply with the terms stipulated in the credit.

 8. Discrepancies

What happens if the “acceptance” (as defined in the ICA, not the Bills of Exchange Act) is not “absolute and unqualified”? A presentation containing discrepancies is nothing but partial acceptance of a proposal. In the UCP parlance, we term such presentations as non-complying. Article 16(a) of UCP 600 says that “when a nominated bank acting on its nomination, a confirming bank, if any, or the issuing bank determines that a presentation does not comply, it may refuse to honour or negotiate.” This is a reflection of Section 39 of the ICA titled, “Effect of refusal of party to perform promise wholly”:

“When a party to a contract [in the case of documentary credits, the beneficiary] has refused to perform, or disabled himself from performing, his promise in its entirety, the promisee[7] may put an end to the contract [“refuse to honour or negotiate”], unless he has signified, by words or conduct, his acquiescence in its continuance (emphasis added).”

Hence, a presentation that does not comply with the terms of the credit in its entirety is liable to be rejected. One may, however, note the similarity between the ICA and the UCP (sub-article 16.b), since both provide an window of opportunity to the beneficiary to seek the issuing bank’s approval of the discrepancies, thereby allowing the “continuance” of the transaction.

Where the acceptance by the promisee (the beneficiary in documentary credit operations) is not “absolute and unqualified”, the so-called acceptance is deemed a fresh offer or a counter offer. This fact is reiterated through Article 19(1) of the CISG which states, “A reply to an offer which purports to be an acceptance but contains additions, limitations or other modifications is a rejection of the offer and constitutes a counter-offer.” These “additions, limitations or other modifications” obviously indicate discrepancies. The original “promisor”, therefore, need not accept the same, resulting in the provision for rejection by the issuing bank (or a nominated bank) of a non-complying presentation.

This “rejection” comes with several conditions. First, sub-article 16(c) of UCP 600 stipulates the manner of rejection. Second, the UCP (sub-article 14.b) stipulates a time limit (five banking days following the day of presentation) for the acceptance or rejection of a presentation. Hence,

“If the proposal prescribes a manner in which it is to be accepted, and the acceptance is not made in such manner, the proposer may, within a reasonable time after the acceptance is communicated to him, insist that his proposal shall be accepted in the prescribed manner, and not otherwise; but if he fails to do so, he accepts the acceptance.”

If the above sounds familiar to you, no reason to be surprised. But tarry a while; do not reach out for the UCP or the ISBP just yet! For, you are sure to be disappointed. The above quote is not from either of these, or from any other publication of the ICC. It is the continuation of sub-section 7(2) of the Indian Contract Act 1872 (ICA). The reason for its appearing familiar to the reader is because the extract is a close reflection of UCP 600 sub-article 16(f), which states,

“If an issuing bank or a confirming bank fails to act in accordance with the provisions of this article, it shall be precluded from claiming that the documents do not constitute a complying presentation.”

Note the expression of “reasonable time” in the ICA quote above. The same expression occurs in UCP 400. A time limit of seven days was added in UCP 500, but the expression “reasonable time” was retained. With UCP 600 coming into being, the expression was removed and a maximum period of five banking days was stipulated. If the bank concerned fails to communicate rejection in the manner stipulated in Article 16, to quote sub-section 7(2) of the ICA, “he accepts the acceptance”. UCP 600 sub-article 16(f) comes into operation.

In this context two interesting points emerge. The first is that, under English law[8], silence does not equate to consent, although a person's conduct can imply consent in certain circumstances (and some might argue that this is an example of “acceptance by conduct”). The second is that, while sub-article 10(f) of UCP 600 applies the principle of “silence does not equate to consent”, sub-section 14(b) does not apply the same principle, but just the opposite, for good reasons.

 9. The confirming bank

A confirming bank is under no compulsion to confirm a credit (UCP 600, sub-article 8.d). However, if it elects to confirm a credit, may we say that it takes on the role of an agent vis-à-vis its principle, the issuing bank? Its responsibilities are defined in Article 8, especially in sub-articles 8(a) and 8(b). One may note that these responsibilities are very similar to that of the issuing bank’s as defined by Article 7 of the UCP. We know that an issuing bank never negotiates; it pays or honours; both being without recourse. As long as an agent acts within its mandate, the acts of an agent binds the principal. Hence, when a confirming bank negotiates, it too does so without recourse (sub-article 8.a.i.ii).

10. The nominated bank

Where does a nominated bank fit into the scheme of things? The LC is wholly a product of the issuing bank (the ‘promisor’), which requires the beneficiary’s complying presentation for the latter to claim payment (“consideration” for its performance under the agreement). The promisor (the issuing bank) stipulates the terms of the “offer” (the LC). Among the terms and conditions, the issuing bank may also nominate the bank(s) to which a complying presentation is to be made (UCP 600, sub-article 6.a). Therefore, a nominated bank, by definition, is a bank that is nominated by the issuing bank to "step into its shoes" and, on its behalf, may offer to honour or negotiate.

Even if a bank is nominated in the credit for honour or negotiation, it is under no obligation to do so (sub-article 12.a, UCP 600). However, once it agrees to bring itself into the loop, agrees to play its part in the transaction, it must be assumed that it has agreed to the parameters set out in the credit; that it has agreed to act within the framework of, and in accordance with, the terms of the credit (and, of course, the UCP). When a nominated bank fulfils its part of the obligations, it is entitled to be compensated (paid) by the “promisor” (the issuing bank) the consideration it is entitled to for having “accepted” the offer (as defined by the ICA). This right of the nominated bank (and through it, to the beneficiary) is created only if (a) the credit is available with it, and (b) the presentation complies fully with the terms of the credit^[9].

The UCP casts certain obligations on the nominated bank, as it does on the confirming bank and the issuing bank. Ready examples are Article 14 and 16. Strangely, however, the rules of the game do not apply uniformly to all the players. Sub-article 16(f) allows a nominated bank (even when it opts to act under the nomination) to get away Scot-free if it fails to comply with the other sections of Articles 14 and 16. In my opinion, the exclusion of the nominated bank from the provisions of sub-article 16(f) of UCP 600 renders the provisions in Article 14 and Article 16 – as far as these are applicable to a nominated bank (acting on its nomination) – infructuous and irrelevant. For reasons of the application of the laws of contract, and for reasons argued in my article Nominated bank and UCP 600^[10], sub-article 16(f) of the UCP should not have selectively excluded a nominated bank from the application of its provisions.

11. Applicant – a “party” to the credit?

This brings us to the vexing issue about whether the applicant – the initiator to the trade transaction, the agreement and the contract between the buyer and the seller, the entity at whose request the documentary credit is issued – is itself a party the very credit it helps to create.

It has been argued in this paper that a documentary credit is in the nature of a contract^[11]. But it’s not the only one. In documentary credit operations, there are a few more agreements and contracts that are directly related. These are, respectively, between:

(a) the buyer and the seller – in the form of pro forma invoice, sales or purchase agreements, etc.;

(b) the buyer (applicant) and the issuing bank – coming into being when the issuing bank sets up financial facilities (bank “limits”) in favour of the applicant for the issue of LCs;

(c) the issuing bank and the beneficiary – the issuing bank giving its written undertaking to the beneficiary, through the medium of the documentary credit instrument, to the effect that if the beneficiary complies with the terms of the credit, the issuing bank on its part would honour its commitment (Article 7 of UCP 600);

(d) the confirming bank (as agent of the issuing bank) and the beneficiary – on terms (Article 8) very similar to those in Article 7 (especially on payment without recourse);

(e) the beneficiary and the negotiating bank – agreement to provide export finance on certain terms and conditions; and finally, between

(f)  the negotiating bank and the issuing bank – an implicit agreement, where the former earns the right to being reimbursed or paid by the issuing bank, by agreeing to, and then carrying out, its specified role as a nominated bank.

One would note that parties in (a) above are not parties to (c) – or, for that matter, to the other contracts or agreements. Sub-article 4(a), UCP 600 reinforces this by stating that, “A credit by its nature is a separate transaction from the sale or other contracts on which it may be based”.

A documentary credit is, thus, a separate stand-alone agreement or contract between the issuing bank and the beneficiary. The applicant, although involved, is not a party to the credit (the specific agreement between the issuing bank and the beneficiary).

12.  Silent confirmation: Covered by the UCP?

In addition to the agreements or contracts listed above, there is another type of contract commonly known as “silent confirmation”. This is usually entered into by way of a separate legal agreement signed by a nominated bank and the beneficiary. If the nominated bank is not requested by the issuing bank to add its confirmation, it may still enter into a commitment to pay, accept or negotiate, i.e. to provide a form of silent confirmation. This agreement outlines the conditions under which the silent confirmation has been granted and the responsibilities of the bank and the beneficiary. The principles covered in the agreement would usually incorporate those conditions expressed in Article 8. One of the main elements of the contract is that the negotiation will be without recourse.

Let us refer to Section 227 of the ICA, which states,

“When an agent does more than he is authorised to do, and when the part of what he does, which is within his authority, can be separated from the part which is beyond his authority, so much only of what he does as is within his authority is binding as between him and his principal.”

Article 8 of the UCP outlines the requirements in respect of confirmation where it has been authorised or requested in the credit by the issuing bank. Silent confirmation/without recourse arrangement is not with the consent, or at the request, of the issuing bank. Therefore, the issuing bank is not a party to this separate agreement or contract with the beneficiary. Consequently, although perfectly legal and valid in law, silent confirmation is outside the terms of the credit and the scope of the UCP (including Article 8). Such contracts, therefore, do not affect or change in any way the issuing bank's original commitment or reimbursement obligation under the UCP to the nominated bank that has negotiated the credit.

13. Negotiation, Purchase, Discount

In commercial bank parlance, the terms below carry the following interpretations as indicated against each (note that these are very general definitions):

(a) Purchase: Advance made against instruments/documents payable on demand i.e. at sight, immediately on presentation. (The term is used for non-LC bills.)

(b) Discount: Advance made against future receivables. (A future income stream is discounted and paid immediately, on presentation. The availability of a usance draft is necessary for non-LC bills.)

(c) Negotiation: Advance against documents presented under credits available by negotiation or (erroneously) by sight payment. (UCP 600, sub-article 6(b) describes four types of credits.)

Unlike “negotiation”, one would have noted the absence of the following:

(a) An expression to define advancing funds against documents presented under credits available by sight payment.

(b) A single expression to define advances made against future receivables, where documents are presented under credits available by acceptance.

(c) A single expression to define advance against documents presented under credits available by deferred payment. (Once again, this also involves discounting future receivables, but a usance draft is not required.)

Any thoughts on filling this gap? Alternately, should the meaning of “negotiation” be extended to cover all transactions under the types of LCs under sub-article 6(b), and leave labelling the various types of advances to the lending banks?

14. Purchase vs. Negotiation

In collection operations, the decision to make an advance, (for example, purchase of or granting overdraft against, export bills on collection) is strictly an arrangement between the remitting/lending bank and the borrowing party – the “principal”^[12]. The collecting/presenting bank and the buyer (drawee) are not parties to the lending decision.

However, in documentary credit operations, negotiation requires another party viz. a “promisor” (for our purposes, it is the issuing bank). In fact, the process begins with the promisor. Next, the beneficiary is required to indicate “acceptance” (as defined by the ICA) in the manner specified in the LC “in its entirety” by the act of delivery of ‘specific performance’ (viz., make a complying presentation). A nominated bank is then required to ensure that the beneficiary of the credit has accepted the offer “in its entirety”; in other words, complied strictly with the terms of the credit. If not, the issuing bank’s approval is required for the continuance (Section 39 of the ICA or sub-article 16.b of UCP 600) of the transaction.

We note from this analysis that a purchase transaction is driven exclusively by the lending bank and the drawer. In contrast, negotiation under documentary credit operations requires an “offeror” or a “promisor”. This “promisor” originates and drives the transaction. Here, compliance with the issuing bank’s terms is the key to its successful conclusion.

15. What is negotiation? ^[13]

One would surely have noted that the performance of the nominated bank included (a) receipt of documents from the beneficiary within the validity of the credit, (b) their examination to ensure compliance (both the actions being on behalf of the issuing bank), and (c) delivery of documents to the issuing bank and receiving payment on behalf of the beneficiary. A nominated bank that has negotiated a complying presentation may need only to expressly indicate on its document remittance schedule that it has negotiated the documents, or be in a position to confirm its negotiation to the issuing bank. “Giving of value” (by way of transfer of cash to the borrower’s account) immediately upon negotiation is not a pre-requisite.^[14]

The million Dollar question here is where, in the scheme of things, does “…advancing or agreeing to advance funds to the beneficiary…” (Article 2, UCP 600, definition of “negotiation”) fit in? Apparently, nowhere! The simple fact is that the issue of a documentary credit and its utilisation is an operation that is distinctly separate from the act of providing loans and advances. The former is driven by the terms set by the issuing bank; the latter is the prerogative of the lending bank. The issuing bank does not require “advancing or agreeing to advance funds” to be a pre-condition for its commitment under Article 7 of the UCP. For loans and advances, it is for a borrower to ask, and for a lender to give. The availability of an LC with the borrower (beneficiary) is only one of the factors (from the risk analysis perspective), but not the only factor relevant to the appraisal process.

It is an irrefutable fact that the popularity of documentary credits would not have reached the pre-eminent position in world trade that it occupies today if the beneficiary had to wait for the maturity date to receive funds against his exports. Documentary credit’s popularity is only because the commercial banks perceive it as carrying very low risk. Financing against LCs are self-liquidating in nature; export bills under LCs (especially those issued by internationally reputed banks) carry far lesser risks, and greater assurance of payment than other modes, like (say) collection bills. Making loans and advances being a major function of commercial banks, they are more than happy to finance borrowers/beneficiaries against documentary credits. LCs help the beneficiaries to obtain export finance with relatively greater ease. For these reasons and more, financing against LCs have come as a very welcome development, and as a natural consequence.

Over the years, this close association between compliance with the issuing bank’s requirements (may I term it as ‘negotiation’?) and financing exports under letters of credit has cemented itself very firmly in our minds. Documentary credit has thus, most unfortunately, become a victim of its own success. It has become extremely difficult, if not well neigh impossible today, to distinguish the negotiating function of documentary credits from its derived function of promoting export finance. The UCP has tied itself up in knots in trying to sail in two boats. This is typified not only by unsuccessful attempts to define ‘negotiation’^[15], but by some of the provisions of the UCP itself that make futile attempts to reconcile the documentary credit’s primary function with its derived one. The upshot is that today we have a far more complicated UCP than there should have been. The time has now come to “un-complicate” the UCP – the UCP focussing exclusively on the rules for documentary credit operations, leaving the banks to manage their lending business in their own way. Otherwise, we have to be prepared for documentary credits to lose the pre-eminent position it occupies in the marketplace today.

16. Doctrine of specific performance

An intense debate has taken place in October-November 2010 (published in the LC Monitor-Trade Services Update, Volume 12, Issue 6) over ISBP 681, Article 4. This article states,

“A credit should not require presentation of documents that are to be issued or countersigned by the applicant. If a credit is issued including such terms, the beneficiary must either seek amendment or comply with them and bear the risk of failure to do so.”

Unfortunately, the above happens to be a very common occurrence. Such ‘clinker’ clauses tilt the credit instrument heavily against the beneficiary, placing him at the mercy of forces beyond his control. For various reasons, the beneficiary quite often is compelled to subject itself to such onerous clauses in the credits and bear all the risks. The Indian Contract Act 1872 has an interesting provision that could, perhaps, come to the beneficiary’s rescue. Section 54 of the Act stipulates as follows:

“When a contract consists of reciprocal promises, such that one of them cannot be performed, or that its performance cannot be claimed till the other has been performed, and the promisor of the promise last mentioned fails to perform it, such promisor cannot claim the performance of the reciprocal promise, and must make compensation to the other party to the contract for any loss which such other party may sustain by the non-performance of the contract.”

The above Section in the Indian Contract Act points towards a welcome relief for the beneficiary who may find himself in similar situations. Taking a leaf out of the above Section, a sub-article on the following lines could perhaps be inserted under Article 14 or Article 16 of the UCP:

"If the LC stipulates submission of any document as part of a presentation by the beneficiary, and the same document is to be generated, issued, authenticated, procured, furnished or submitted by (or at the behest of) the applicant or the issuing bank – essentially meaning, where the responsibility (partly or wholly) for making it available to the beneficiary or the nominated/issuing bank in its final, completed or compliant form is with the applicant or the issuing bank (as the case may be) – non-presentation of the same by the beneficiary will not constitute a discrepancy."

17.  Court decisions

A highly informative paper by Mr. Chang-Soon Thomas Song^[16] discusses the “Different court decisions around the world on deferred payment credits” in the context of frauds coming to light after payment by the nominated bank to the beneficiary but before payment/reimbursement by the issuing bank. While it is not possible to quote the detailed analysis by Thomas Song or opinion of the courts, the following could be of our immediate interest^[17]:

1.     “The Swiss Supreme Court held that if the confirming bank remains free to prepay an irrevocable letter of credit with deferred payment credit without advising the issuing bank, the confirming bank that acts in this way must assume the risks of a fraud revealed subsequently to the granted discount, but before the due date of the documentary credit.” (Emirates Bank International v. Credit Lyonnais (Suisse) S.A., Decision 1 June 2004, Tribunal Federal.)

2.     “The English Court of Appeal held that in the view of the judge, the position is that Santander had no authority to negotiate from Paribas or to discount, and did not seek it. It was something they were entitled to do on their own account. If they had not chosen to discount and had waited until 27th November 1998 [maturity date], they would have had a defence, and it is in those circumstances not open to them to claim reimbursement from Paribas.”

The Court added that if a confirming bank in the position of Santander wishes to be free to give value for documents when it accepts the documents, it can do so either by insisting on the use of an acceptance credit or by insisting on obtaining authority to negotiate and confirmation of reimbursement if it does. If Santander had informed Paribas that it had discounted, and had received confirmation from Paribas that Paribas would still reimburse on 27th November 1998, Paribas would not be able to raise the fraud exception, because they would be estopped from disputing Santander’s authority to discount.” (Banco Santander v Banque Paribas, Decision 25 February 2000, Court of Appeal (Civil Division).)

3.     “The Korean Supreme Court held that when a bank has been nominated by the issuing bank to pay the proceeds [of documents] by purchase of shipping documents, as long as no contrary agreement exists, it is correct to consider it as included in the authorization given to the nominated bank by the issuing bank that even if the nominated bank negotiates the shipping documents before the maturity date for the payment of proceeds of the deferred payment letter of credit, the issuing bank binds itself to reimburse the said payment at the maturity date.” (Industrial Bank of Korea v. BNP Paribas, Decision 24 January 2003, Korean Supreme Court 2001 DA 68266 quoted in Judge Dong-Heon Chae, International Business and Law (Law of Letters of Credit). 2004.)

I would like to draw attention of the readers only to the following issues:

(a) The courts considered the (so-called) linkage between LCs and the (implied, specific or prior) authorization to the nominated bank by the issuing bank through the documentary credit instrument to advance funds to the beneficiary.

(b) For arriving at their decisions, the merit of the respective cases (which involved fraud, not with document credit operations per se) were decided by the concerned courts taking into account the acts of advance or pre-payment by the nominated banks while processing documents presented under documentary credits.

(c) The courts’ observations about obtaining prior or post-facto authorisation to negotiate/discount by the nominated bank appears unrealistic, not workable in practice.

I wonder what the decisions of these courts would have been if they had considered the following:

(1) As argued in this article, negotiation by nominated banks under issuing banks’ letters of credit is a function that is distinctly separate in nature from banks’ loans and advances (including pre-payment) operations.

(2) LCs as a rule (exception, a red clause credit) contain no authorisation or directive to another bank to extend financial facilities to a beneficiary. Lending decisions are the sole prerogatives of the parties (lender and borrower) concerned. This issue, therefore, ought not to have figured in the judgements delivered by the courts.

(3) The issues under consideration by the courts should have been confined to (a) the incidence of fraud, and (b) whether, in such fraud situations, the issuing bank (applying Article 7 of UCP 600) continued to be obliged to pay. (I may venture to opine that the Korean Supreme Court was correct in its approach, not the other two.)

Incidentally, were the incidences of fraud established; were the perpetrators identified and brought to book, and the losses recovered?

18. Conclusion

The above is a layman’s attempt to interpret the provisions of the UCP in the light of the Indian Contract Act 1872. I am sure the erudite readers and the experts would find other clauses of the UCP the rationale of which can be explained in the context of the ICA (e.g. Article 1, sub-articles 10.a, 10.c & 10.e, sub-articles 7.c and 8.c etc.), thus helping us to appreciate the UCP better.

Documentary credits and bank finance (termed ‘pre-payment’ by the UCP) have fed on each other, drawn strength from each other, helped each other to prosper and grow. The world business community has gained tremendously from the close association and cross-pollination. It goes without saying that trade and commerce, benefiting from this association, have developed to an extent that would never have been possible otherwise.

I hope this analysis adds a fresh perspective on matters relating to letters of credit. In the interest of global trade, there is an urgent need to understand the distinct functions of letters of credit very clearly, streamline and modify the rules to further improve its operations, while simultaneously protect the documentary credit instrument (and the UCP) from being viewed through lenses distorted by misplaced expectations or perceptions that it can hardly live up to.

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availability and expiry under ARTICLE 6, UCP 600

Rupnarayan Bose^[1]

1. Introduction

I am sure one can easily recall the following lines from the popular musical The Sound of Music:

“How do you solve a problem like Maria?

How do you catch a cloud and pin it down?”

Replace ‘Maria’ with issues like negotiation, pre-payment, drafts, shipment date – you name it – and you may feel like I do about some of the provisions in the UCP. This article is yet another attempt to make sense out of availability and expiry under Article 6 of UCP 600.

2. Sub-articles 6 (a) & (d)

Sub-article 6(a) states, “A credit must state the bank with which it is available or whether it is available with any bank. A credit available with a nominated bank is also available with the issuing bank.”

Sub-article 6(d)(i) reads as follows, “A credit must state an expiry date for presentation. An expiry date stated for honour or negotiation will be deemed to be an expiry date for presentation.” Note that this sub-article calls for only the date of expiry, not the place of expiry of a credit.

Sub-article 6(d)(ii) states, “The place of the bank with which the credit is available is the place for presentation^[2]. The place for presentation under a credit available with any bank is that of any bank^[3]. A place for presentation other than that of the issuing bank is in addition to the place of the issuing bank.” According to this sub-article, the place where a credit is available goes hand in hand with the bank with which a credit is available and its (geographical) location. This sub-article appears axiomatic, no more than explanatory in nature, a reiteration of a situation that should, ordinarily, be a given.

3. Under Article 6 place of expiry not required in LCs

Article 6 ordains that the place where the nominated (or the issuing) bank is located is the place where a credit would be deemed to be available. Nowhere does Article 6 – or the rest of the UCP for that matter – require a credit to state a place for its expiry, just the date (of expiry). This is because the place for presentation or availability is effectively determined by sub-article 6(d)(ii). Extending this a little further, since presentation to a nominated (or the issuing) bank cannot but be made at its physical location, the effective utilisation of a credit must also be only at that place. It follows that the useful life of a credit, to the extent of its utilisation, should also be deemed to have expired at that same geographical location. Following Article 12, the transaction is not vitiated if the negotiated documents reach the issuing bank after the expiry date of the credit. The issuing bank must honour, if the documents otherwise comply (Article 7).

4. The problem areas

We are long used to seeing documentary credits indicate both “date and [a] place of expiry”. If both are the same in a credit, determining availability poses no problem. The problems begin when the places of availability and expiry differ, e.g.:

1. The credit is available with (SWIFT MT 700, Field 41A) the issuing bank in country A. The place of expiry (SWIFT MT 700, Field 31D) is in the beneficiary’s country, viz., country B.

2. The credit is available with a nominated bank in (beneficiary’s) country B; its place of expiry is in (issuing bank’s) country A.

3. Credit confirmed by a bank in country A. It is available with a(ny) bank at the beneficiary’s place, say, country B, or the issuing bank’s country (C).

(Such credits are not necessarily “badly drawn”. Banks in Africa or Latin America often require credits issued by them to be confirmed by their international correspondent banks operating out of the UK or US for these LCs to be accepted by beneficiaries in third countries.)

5. The first example:

In this example, the credit is available in country A; it expires in country B (the beneficiary’s place of business). The interpretations are follows:

(a)   "[Here] the beneficiary has the ability to present the documents to a local bank up to the expiry date.^[4] … [T]he expiry is merely a date for presentation of documents, within the country of the beneficiary. The documents may reach the issuing bank after the expiry but provided they were presented in the country of the beneficiary, within the expiry and otherwise comply, they must honour.^[5]”

(b)   The credit is not available in country B. No bank in the beneficiary’s country – including the “local bank” (as it appears from the foregoing) – is authorised to honour or negotiate documents under the credit.

(c)   Under such credits, the beneficiary’s only apparent advantage is that he has the option to present documents to a “local bank” within the expiry of the credit or the last date of presentation – whichever is earlier – but is denied the benefits of negotiation or honour.

If the beneficiary requires a bank in his country or place of business to honour or negotiate the documents, he must get the credit amended to make it available in country B.

(d)   Since the credit is available (with the issuing bank) in country A, the issuing bank is entitled to “act” under the credit.

The only advantage the issuing bank gets out of such credits is that it ensures receipt of documents prior to the credit’s date of expiry.

Yet, questions remain. No bank in country B is named in the credit as a nominated bank – not even for the limited purpose of the LC’s expiry (the credit is not available in B). The credit does not “expressly modify” (Article 1) the UCP. The “local bank”, whichever or wherever it may be located in country B, would obviously be acting outside the UCP. If  that be so, why would the submission of documents to a bank that is not a nominated bank under the credit, located in a country where the credit is not available, be acceptable, beats me! To the best of my understanding, such submissions should not be considered valid presentations under the UCP, nor be protected by it.

The question is, even though

      (a)  the requirement by SWIFT of a place of expiry in a credit is outside the scope of the UCP,

      (b)  the credit is incorrectly drawn, is unworkable in practice (it expires in a country where it is not available for negotiation),

      (c)  the “local bank” in country B is not a nominated bank,

by accepting a so-called presentation (in country B) as valid, are we not going beyond the UCP to sanctify an obviously defective, badly drawn LC? A typical example of forcing a square peg in a round hole, but to what purpose?

6. The second example:

Interpretations:

   (1)  The credit is available with a bank or banks in country B. The beneficiary may, therefore, present documents to the nominated bank in country B for honour or negotiation. But this is only part of the story!

   (2)  Since the credit expires (with the issuing bank) in country A, “the nominated bank must determine whether they are in a position to offer honour or negotiation and [simultaneously] ensure delivery of the documents to the issuing bank within the expiry date or any last date for presentation.”^[6]

   (3)   Alternately, the beneficiary must “present” the documents direct to the issuing bank no later than the expiry date stated in the credit or within the specified number of days after shipment (or 21 calendar days if no period is mentioned) – whichever is earlier.

The issues are as follows:

(a)    Through such credits, the issuing bank ensures only the delivery of documents within the expiry date stated in the credit. But it imposes avoidable constraints on the beneficiary and the negotiating bank. It is important to note that such an obligation of a nominated bank is not expressly or implicitly imposed by the UCP through Articles 12 or 15 – especially sub-article 15(c).

(b)    If the nominated bank (wherever it may be located) negotiates or honours, the LC should normally stand utilised at that point itself. There should not be any requirement thereafter for the documents to be rushed to the issuing bank to meet the deadline for the presentation of documents (the expiry date of the LC).

(c)    Field 31D, working outside the UCP, appears to be creating room for avoidable complications in documentary credit operations, including disputes, possible discrepancies, and rejection of documents.

7. When is the confirming bank a nominated bank (third example)?

The last of the examples brings us to an issue that is still a subject of debate. Sub-article 8(a) in a somewhat misleading manner begins with the words, “Provided that the stipulated documents are presented to the confirming bank or to any other nominated bank and that they constitute a complying presentation, the confirming bank must:….” (emphasis added). By inserting the word “other”^[7] precisely where it is placed in the sentence, the expression “nominated bank” seems to include in its ambit a confirming bank. (Just take the word “other” out of this section, and see how the meaning of the sentence changes.)

Two separate articles in DC Insight issue of October-December 2009 by Mr. Kenny Wang and Ms. Wangofei respectively, and also the article titled Reimbursing the confirming bank under SWIFT Field 41A by Haluk Erdemol^[8] add to the debate. Commenting on the two preceding articles, and especially on credits available with only the issuing bank, but requested to be confirmed by the advising bank, Erdemol states, “When an issuing bank nominates a bank to confirm a credit, the credit must be available with the confirming bank along with an expiry date to be valid at the latter’s place or country. Otherwise, what would be the role of a confirming bank if only the issuing bank would be able to honour?...” Precisely the question that everybody is would love to have an answer to.

He concludes, “The statement quoted from the Commentary on UCP 600 means that a confirming bank may not be a nominated bank vis-à-vis the beneficiary, and it has been misinterpreted by the commentator at the cost of disregarding the relationship between the confirming bank and another nominated bank set out in Article 8.”

I do not believe that, in practice, the “relationship” he refers to would make any difference to anyone. The issue is nailed by Commentary on UCP 600 which while referring to Article 12 (page 53) states, “It should be noted that, subject to the structure of the documentary credit, a confirming bank may not be a nominated bank.” Gary Collyer too observes that, “[a] confirming bank need not be a nominated bank….. [For the confirming bank] to be a nominated bank, the credit must so specifically state.”^[9]

Clearly, if the confirming bank is not the “nominated bank vis-à-vis the beneficiary”, the beneficiary is not permitted to present complying documents to the confirming bank for negotiation or honour, nor be protected by the UCP. The beneficiary, therefore, can neither utilise the LC nor benefit from the confirmation. Of what good it is, then if, according to Erdemol, the confirming bank is a nominated bank vis-à-vis only the issuing bank?

A close reading of sub-article 8(a)(i)(a) and 8(a)(ii) would show very clearly that for the confirming bank to negotiate or honour, the credit must be “available …. with the confirming bank.” The issuing bank must, therefore, specifically nominate, or extend the availability of the credit to include, the confirming bank (ref. SWIFT MT700, Field 41A) if Article 8 is to be complied with.

8. The problems with availability: suggested solution

Where did the problems with availability start? The ICC may say, “We didn’t start the fire….”, but they must share the responsibility. The cause lies with S.W.I.F.T., especially their definition of Fields 41A and 31D (MT700).

Regarding Field 41A, “Available with... by...”, SWIFT usage guidelines^[10] state, “This field identifies the bank with which the documentary credit is available (the place for presentation) and an indication of how the credit is available...”. This is absolutely in sync with sub-articles 6(a) and 6(b).

The same “guidelines” interpret Field 31D, “Date and Place of Expiry” of the MT 700 etc. as follows: “This field specifies the latest date for presentation under the documentary credit and the place where documents may be presented...”.

My comments:

1. Field 31D introduces an altogether unique element, i.e. a place of expiry – quite unwarranted, not envisaged under Article 6 of UCP 600 (especially not under sub-articles 6(d)(i) or 6(d)(ii)).

2. It would not have mattered in the least where a credit was set to expire as long as it stated when it expired (“A credit must state as expiry date for presentation” – sub-article 6.d.i), had not Field 31D queered the pitch.

3. The unfortunate (mis)interpretation by S.W.I.F.T., equating “place of expiry” of a credit with “the place where documents may be presented”, flies directly in the face of sub-article 6(d)(ii).

4. This has also cast an obligation on the nominated bank not envisaged in the UCP.

Oh, what a tangled web we weave….!

The solution is simple enough. S.W.I.F.T. should immediately delete “and place” under Field 31D (from MT700 and others), leaving only the date of expiry.

9. As things stand today

1. Ideally, the place of expiry and the place of availability of a credit should be the one and the same. Would the issuing banks please note of this point?

2. Where the places of availability and expiry differ, and till corrective action is taken, the beneficiary and the nominated bank should keep an watchful eye on the landmines.

3. By confirming a credit, a confirming bank does not automatically become a nominated bank. For a credit to be available with the confirming bank the credit must so specifically state. Otherwise the fees paid to the confirming bank go up in smoke (or, down the drain, take your pick!).

If only we could work together to un-complicate the UCP! If only the ICC take note of these pressing issues and act SWIFT-ly! In the words of Eliza Doolittle, “Wouldn’t it be loverly!”^[11]

References:

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Nominated bank and UCP 600

Rupnarayan Bose

This article analyses the roles and responsibilities of a nominated bank under selected provisions of UCP 600.

Article 6(a) of UCP 600 requires that a “credit must state the bank with which a credit is available”. This bank has been defined under Article 2 as the ‘nominated bank’. A nominated bank could be a bank specifically designated by the issuing bank for the purpose of negotiation or honour of documents. Alternately, it may be any bank. According to sub-article 7(c), the issuing bank’s undertaking to reimburse under its own LC is restricted only to a nominated bank. Note that the bank that has added its confirmation to a credit need not necessarily be a nominated bank.

Let us focus on the first major article on nomination, viz., Article 12. Sub-article 12(a) states:

“Unless the nominated bank is the confirming bank, an authorisation to honour or negotiate does not impose any obligation on the nominated bank to honour or negotiate, except where expressly agreed to by the nominated bank and communicated to the beneficiary.”

A simple reading of sub-article 12(a) conveys the following:

a)   An issuing bank may authorise a nominated bank to honour or negotiate (under its own credit).

b)  Such authorisation casts no obligation (to honour or negotiate) on a nominated bank that has advised the credit to the beneficiary.

c)  The obligation (to honour or negotiate) is imposed on the nominated bank (which usually is the advising bank) if it also the confirming bank. This is reiterated in Article 8, especially sub-articles 8(a)(ii) and 8(b).

d)  A nominated bank may, of its own volition – through an ‘express agreement’ between itself and the beneficiary – create an obligation to honour or to negotiate.

However, such ‘express agreement’ is a contractual obligation that subsists entirely between a nominated bank and the beneficiary. It is outside the UCP. Further, “[t]he fact that a nominated bank agreed to advance funds on a future date (i.e. on or prior to the date reimbursement was due) does not bind that bank to acting accordingly on the date the advance was expected or due (emphasis added).”^[1]

If we rephrase sub-article 12(a), it could read as follows:

“Unless the nominated bank is the confirming bank or has expressly agreed to honour or negotiate and so communicated to the beneficiary, an authorisation to honour or negotiate does not impose any obligation on the nominated bank to honour or negotiate.”

In spite of what could very well be erroneously concluded from the construction of this sub-article, as far as the UCP is concerned, there is no difference whatsoever between a nominated bank “that is not a confirming bank [which] advises a credit [to the beneficiary] without any undertaking to honour or negotiate” (sub-article 9.a), and a nominated bank that “expressly agreed to [honour or negotiate] …and so communicated to the beneficiary” (sub-article 12.a). In either instance, a nominated bank enjoys exactly the same privilege and protection under the UCP, no more and no less.

Some say that sub-article 12(a) has probably been structured to provide for what is known as ‘silent confirmation’. Once again, such ‘silent confirmation’ is nothing more than a contractual agreement between a (nominated/lending) bank and the beneficiary/borrower. Such ‘silent confirmation’ lies outside the scope of the UCP. The nominated bank that extends ‘silent confirmation’ is in no better position, receives no greater protection under the UCP, than a nominated bank that offers no ‘express agreement’ to a beneficiary.

Sub-article 12(a) thus seems a mere repetition of the essence of sub-article 9(a). It adds no value, serves no distinct or unique purpose except to add to the confusion surrounding the obligations of a nominated bank. Unless it is reworded to remove the confusion caused by its present construciton, sub-article 12(a) should be deleted.

Next, a few words about sub-article 12(b). By definition, a documentary credit is available only with a nominated bank by sight payment, deferred payment, acceptance or negotiation. However, this sub-article provides for an issuing bank to authorise “that nominated bank to prepay [an euphemism for advancing funds] or purchase a draft accepted or a deferred payment undertaking incurred by that nominated bank.”

The decision to advance money to anyone (including the beneficiary of a documentary credit) is always an internal decision of the lending institution (in this instance, the nominated bank). Unless the ‘authorisation’ referred to in sub-article 12(b) includes some form of guarantee or risk-participation by the issuing bank, this sub-article serves no useful purpose as far as the lending institution is concerned (Banco Santander case notwithstanding).

Which brings me back to the true purpose of the UCP and documentary credits. A letter of credit is essentially a contract between the issuing bank and the beneficiary – calling on the latter to specific performance through presentation of documents in compliance with the terms of the credit. Examined closely, issues regarding lending (money) are actually outside the domain of letters of credit. Therefore, lending decisions and risk management are matters that are best left to the lender and the borrower. In my opinion, the UCP should focus solely only on the operations of documentary credits. A consequent simplification of the UCP would reduce rejections, streamline compliance, promote world trade, and encourage greater usage and acceptability of LCs worldwide.

Let us now revert to Article 1 of UCP 600. It stipulates that the provisions of the UCP “are rules that apply to any documentary credit ... when the text of the credit expressly indicates that it is subject to these rules. They are binding on all parties thereto unless expressly modified or excluded by the credit.” Accordingly, sub-article 14(a) applies to “a nominated bank acting on its nomination, a confirming bank, if any, and the issuing bank.” So does the provision regarding the period of examination of documents as envisaged in sub-article 14(b).

Although not clearly similarly stated in the remaining part of Article 14, one can safely assume that the Rules as laid down in sub-articles 14(c) to 14(l) are also required to be complied with by “a nominated bank acting on its nomination, a confirming bank, if any, and the issuing bank” – as the case may be.

One may take note of the fact that sub-articles 16(a), 16(c) and 16(e) too cast clear and specific responsibilities on these banks – without exception. The role and the responsibilities of the nominated bank as well as the other banks have been spelt out in unambiguous terms at every place in Articles 14 and 16.

This brings us to sub-article 16(f). It stipulates that, if the issuing bank or the confirming bank fails to act in accordance with the provisions of this article (Article 16, and by extension Article 14), it would have to face certain consequences. Specifically, the concerned bank shall then be precluded from claiming that the documents do not constitute a complying presentation. Strangely, the nominated bank escapes this penal provision.

The issuing bank undertakes clearly defined obligations under Article 7 of UCP 600. The confirming bank does so under Article 8. One may argue that since an advising or a nominated bank is under no obligation to honour or to negotiate (unless it confirms the credit), it has no responsibility – and is therefore excluded from the application of sub-article 16(f). This is strange logic indeed.

Admittedly, unless it has confirmed a credit, a nominated bank is under no obligation to honour or negotiate even if complying documents are presented to it. However, once it agrees to honour or negotiate a complying presentation, it automatically and irrevocably subjects itself to the rules of the game (namely, the UCP). The rules – without exception – are supposed to be binding on all parties thereto (Article 1). This is evidenced by clear stipulations in Article 14 and Article 16 where the responsibilities of the nominated bank (as also the issuing bank and the confirming bank) are clearly spelt out.

When a nominated bank agrees to join the game, it consciously accepts the rules of the game. The rules should apply in totality, not selectively. There is no reason why a nominated bank should not be subjected to exactly the same rules, privileges and penalties that are applicable to an issuing or a confirming bank. The critical issue that we ought to address here is, whether the exclusion of the nominated bank from sub-article 16(f) renders the provisions of Article 14 and Article 16 – as far as these are applicable to a nominated bank (acting on its nomination) – infructuous and irrelevant. Only on this score alone, a nominated bank should be included in sub-article 16(f), and be subjected to the application of this sub-article.

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NEGOTIATION AND THE LAW OF CONTRACT[1]

Rupnarayan Bose

 1. Introduction

In trade finance and documentary credit operations, the word “negotiation” remains an enduring enigma. No one described the situation better perhaps than the late Ole Malmqvist, a member of the UCP 600 Drafting Group, who, in a DCInsight interview, said:

“ … there has been an extended discussion about the word negotiation, which nobody can define and which only a few want to get rid of … I'm still looking for someone who can explain to me the difference between payment and negotiation … so far no one has been able to come up with a definition, not one I have seen, at any rate, so I doubt that anyone will be able to come up with a definition now … The word ‘negotiation’ is a problem … I think we should get rid of the word ‘negotiation’, because we cannot define it and because we don't need the concept^[2].

He added:

“ … Every L/C expert knows exactly what negotiation is/means. But ask any three of them for their interpretation and be prepared to receive three different answers!^[3]”

Reinhard Längerich, a former member of the ICC Banking Commission, said^[4]:

“I am convinced that by removing the term ‘negotiation’ and ‘the right of recourse against the beneficiary’ [from UCP], we would make the letter of credit a more reliable instrument.”

But the fact remains that, in spite of these severe criticisms, negotiation is alive and well and is included in the latest version of the UCP. Since we must continue to live with it, this article is yet another attempt to explain the concept and to provide yet another answer.

2. UCP 600 definitions

Article 2 of UCP 600 defines negotiation as follows: “Negotiation means the purchase by the nominated bank of drafts (drawn on a bank other than the nominated bank) and/or documents under a complying presentation, by advancing or agreeing to advance funds to the beneficiary on or before the banking day on which reimbursement is due to the nominated bank.”

This definition appears to be flawed for the following reasons^[5]:

(1)       “Negotiation means the purchase … of drafts (drawn on a bank other than the nominated bank) … and/or documents … etc.”: In my view, the terms “negotiation” and “purchase” are not interchangeable, for reasons I will advance later.

(2)       “Negotiation means the purchase … of … by advancing or agreeing to advance … ”: an “agreement to advance funds” is not the same as an advance or loan (or any liability, for that matter) outstanding in the books of a bank against a borrower. There is no certainty that an agreement will be converted to a loan in the future. An “agreement to advance funds” creates no obligation or liability against the borrower, carries no risk exposure for the lender and does not affect the balance sheets of either the lender or the borrower. Moreover, the issue of recourse or non-recourse payment does not arise.

(3)       “ … on or before the banking day on which reimbursement is due to the nominated bank”: the words “on or” should have been deleted. Where the value date of reimbursement and the so-called “advance” is the same, no liability or advance would be outstanding on a bank’s books. The bank takes no credit decision, does not pay from its own funds, is not out of pocket and creates no non-fund liability. There is no “purchase” or “negotiation”, no risk exposure whatsoever and hence, no advance.

3. More confusion about negotiation

Let us examine the following scenarios:

(a)“Negotiation means the giving of value for draft(s) and/or document(s) by the bank authorized to negotiate. Mere examination of the documents without giving value (emphasis mine) does not constitute a negotiation.” (UCP 500, sub-article 10 (b) (ii). Has this principle undergone a change in UCP 600? What should be defined as “giving value”?;

(b)     “Receipt or examination and forwarding of documents by a nominated bank that is not a confirming bank does not … constitute honour or negotiation.” (UCP 600, sub-article 12 (c);

(c)“The fact that a nominated bank agreed to advance funds on a future date (i.e., on or prior to the date reimbursement was due) does not bind that bank to acting accordingly on the date the advance was expected or due (emphasis added)^[6].

It is strange logic which claims that a mere promise or revocable agreement to provide value (definition or extent of exposure still indeterminate) on any future (but indeterminate) date is contained in the definition of negotiation, whereas sending the very same documents “on an approval basis”, or for acceptance by the issuing bank (well before funding is provided to the beneficiary), is not.

4. The laws of contract

What then is negotiation and how should it be defined? To explain the concept it is necessary to find a point of reference, a peg to hang it on. Section 2 (Interpretation Clause) and a few other clauses of the Indian Contract Act, 1872 (modelled on the English Contract Laws) provides a convenient platform for this exercise. Loosely translated, its selected sub-clauses under Clause 2 are as follows:

(a) When one person signifies to another his willingness to do or to abstain from doing anything, with a view to obtaining the assent of that other to such act or abstinence, he is said to make a proposal (or an offer).

(b)   When the person to whom the proposal is made signifies his assent thereto, the proposal is said to be accepted. A proposal, when accepted, becomes a promise.

(c)  Every promise and every set of promises, forming the consideration for each other, is an agreement.

(d)  An agreement not enforceable by law is said to be void. An agreement enforceable by law is a contract.

(e) Performance of the conditions of a proposal, or the acceptance of any consideration for a reciprocal promise which may be offered with a proposal, is an acceptance of the proposal.

Clauses 7 and 8 of the Act state:

7.     “In order to convert a proposal into a promise, the acceptance must -

(a)  be absolute and unqualified;

(b)   be expressed in some usual and reasonable manner, unless the proposal prescribes the manner in which it is to be accepted. If the proposal prescribes a manner in which it is to be accepted, and the acceptance is not made in such manner, the proposer may, within a reasonable time after the acceptance is communicated to him, insist that his proposal shall be accepted in the prescribed manner, and not otherwise; but if he fails to do so, he accepts the acceptance.

8.   Performance of the conditions of a proposal, or the acceptance of any consideration for a reciprocal promise which may be offered with a proposal, is an acceptance of the proposal.”

5. Negotiation and the laws of contract

When comparing a letter of credit to the above, we observe the following:

1. A letter of credit is an explicit proposal, specifically addressed to a person (the beneficiary) named in the credit;

2. The proposal (in the form of a letter of credit) specifies the “manner in which it is to be accepted”;

3. A complying presentation to a nominated bank constitutes “performance of conditions of the proposal” (the L/C) “in the manner prescribed”; it signifies “an acceptance of the proposal”. The acceptance (performance) entitles the beneficiary and the negotiating bank (as agent) to receive consideration under the contract; 

4. Where the presentation is discrepant, obviously “the acceptance is not made in such manner” as prescribed by the proposer (sub-clause 7 (b) of the Indian Contract Act. It is “a reciprocal promise … offered with a proposal”. The acceptance is not “absolute and unqualified”. We may call it a conditional acceptance, a fresh proposal or counter-offer. Continuing with sub-clause 7(b), if the acceptance is not “unqualified” (the presentation being discrepant), the proposer – i.e.. the issuing bank – within a reasonable time after ascertaining the discrepancies, is within its rights to insist that its proposal be accepted only in the prescribed manner (in compliance with the credit terms); otherwise it can refuse the documents (sub-article 14 (b) and article 16 of UCP 600).

However, if the issuing bank (the proposer) fails to convey refusal along with the reasons for doing so, it must (or is deemed to) accept the “reciprocal promise”, conditional acceptance or counter-offer (refer to sub-article 16 (f) of UCP 600).

5.     By confirming a credit, a confirming bank steps into the shoes of the issuing bank. For this reason, payment by a confirming bank is without recourse.

6. Negotiation: the concept

Negotiation essentially denotes a process within this framework. The focal point of this process is compliance – “absolute and unqualified” acceptance of the issuing bank’s proposal (a complying presentation). A negotiating bank is an essential link in this chain, being nominated by the proposer/offerer (the issuing bank), in terms of UCP 600 article 6, as a necessary condition for the performance of the beneficiary and “the manner in which it [the L/C terms] are to be accepted”. If a presentation (i.e., the act of acceptance by the beneficiary) is at variance, the presentation does not comply, then sub-clause 7 (b) kicks in. The spirit of this clause is reflected in Article 16 of UCP 600.

7. Purchase, collection

In collection transactions, the difference lies in the fact that if the subsisting promise or offer, call for “acceptance” or “performance” along the lines as described in the laws of contract – this is between the buyer and the seller. There is no issuing or negotiating bank. The intermediary banks are not required to verify compliance. If a bank decides to purchase the documents submitted, it is a financing decision – purely between the lending bank and the borrower.

8. Negotiation, financing and the UCP

Consequently, in my view negotiation has everything to do with performance or compliance under documentary credits; it has nothing to do with financing. Unfortunately, in its attempt to straddle two dissimilar functions, in trying to be everything to everyone, the definition of the term negotiation may have caused more confusion, debate, argument and frustration than contemplated. The UCP should be de-linked from all forms of financing (including advancing or agreeing to advance funds), terms of payment, pre-payment, payment with or without recourse. The following revised definition is suggested as a way forward: “Negotiation means the complying presentation of drafts (drawn on a bank other than the nominated bank) and/or documents to a nominated bank, and its declaration on its covering schedule that it has negotiated against a particular documentary credit of the issuing bank.”

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Editor’s comment (quoted from DC Insight):

“….And in our Expert commentary, one of our new writers, Rupnarayan Bose, takes another look at negotiation, this time from the point of view of contract law. We’ve run a long series of articles on negotiation in the past, but since we thought Mr. Bose approached it from a new angle, we have given this piece a certain prominence in this issue.” (Signed: Ron Katz, Editor, DC Insight)

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Re-defining ‘negotiation’

Rupnarayan Bose

 1. Background

The term ‘negotiation’ has defied definition since its inception. As far back as the early 1980s people have been asking what negotiation was supposed to mean. Integral to the meaning of negotiation is the issue about recourse payment. The confusion about correct interpretation and application of the term ‘negotiation’ is not confined to laymen like me, but has troubled some of the experts in the business.

The late Ole Malmqvist, a member of the UCP Drafting Group for UCP 600 said,

“.... there has been an extended discussion about the word negotiation, which nobody can define and which only a few want to get rid of.... I'm still looking for someone who can explain to me the difference between payment and negotiation .... so far no one has been able to come up with a definition, not one I have seen, at any rate, so I doubt that anyone will be able to come up with a definition now .... I suggested that we get rid of the word negotiation.... The word ‘negotiation’ is a problem.... In short, I think we should get rid of the word ‘negotiation’ because we cannot define it and because we don't need the concept….

“Every L/C expert knows exactly what negotiation is/means. But ask any three of them for their interpretation and be prepared to receive three different answers! (Yet another reason to get rid of the term ‘negotiation’!) No one has been able to come up with a definition that everyone can agree on,…..”.(DC Insight)

Reinhard Längerich commented[i]:

“I am convinced that by removing the term 'negotiation' and 'the right of recourse against the beneficiary' [from UCP], we would make the letter of credit a more reliable instrument.”

Robert M. Rosenblith, Esq. says[ii]:

“Essentially, it was (and still is) my opinion that unless a bank ‘negotiates’ without recourse, it is merely a collecting bank. …..Negotiation is intended to confer a benefit on the beneficiary by affording it a final payment, the same type of payment an issuer makes. Any payment that can be recovered (absent for fraud) is not a final payment.”

2. Negotiation: A flawed definition

“Negotiation” is defined in Article 2 of UCP 600 as follows:

“Negotiation means the purchase by the nominated bank of drafts (drawn on a bank other than the nominated bank) and/or documents under a complying presentation, by advancing or agreeing to advance funds to the beneficiary on or before the banking day on which reimbursement is due to the nominated bank.”

As if the confusion about the meaning of the term, since it was created, was not enough, now we have serious problems with the definition itself. The definition appears to have serious flaws, for reasons stated below:

(1) “Negotiation means the purchase….of drafts (drawn on a bank other than the nominated bank)…and/or documents …etc.” I believe that ‘negotiation’ and ‘purchase’ have different implications, hence cannot be interchanged. The term ‘negotiation’ implies advancing funds under some sort of mandate or authorisation (e.g. a letter of credit) from a third party. The term ‘purchase’ is used where a mandate or authorisation is absent in a transaction (e.g. purchase of collection bills under URC 522).

(2) “Negotiation means the purchase….of…by advancing or agreeing to advance…”: Nowhere in the banking industry an agreement to advance is equated with the release of an advance facility, the creation of a liability. An act of ‘purchase’ is by no means the same as merely ‘agreeing to advance funds’. The ‘agreement to advance’ is the culmination of a formal process leading up to, but not the same as, the actual release of an advance. The former includes application, appraisal, approval, sanction letter (communicating type and ceiling amounts of facilities approved, terms and conditions), execution of documents, creation of securities, legal formalities and so forth.

The communication of sanction (say, to the beneficiary) is the act of formally “agreeing to advance funds to the beneficiary”, or of non-fund (i.e. fee based) facilities. This facility may include an LC limit, negotiation (if under LC) or purchase (if not under LC) of export bills – depending on what the borrower wants and the lending bank approves. However, everything said and done, it is no more than an agreement. It is not the same as an actual risk exposure by the lending institution.

It must be appreciated that an exporter’s cash flow problem cannot be solved by a mere ‘promise to pay’. ‘Agreeing to advance funds on a future date’ does not help the exporter receive money against export bills, funds to pay salaries or cash to his suppliers.

T O Lee’s says[iii],

“Some beneficiaries in the US ask the nominated banks to issue a written undertaking to agree to negotiate when it is needed by the beneficiary at a future time if the documents comply. This is done to prepare a ‘finance umbrella’ whereby funds can be used to purchase raw materials or buy goods from other parties, etc. That letter to undertake to negotiate in case of need is sort of an ‘agreement to advance fund.”

I am in complete agreement with him. Banks do not encourage ad-hoc request for financial facilities. A formal process as described above is the general practice. The letter of approval or sanction (as referred by T O Lee) issued by a bank to a prospective borrower is not only an undertaking “to negotiate in case of need”, is not only a “sort of an ‘agreement to advance fund’”, but is a formal communication of an arrangement (being in place) to release the funds/facilities as and when requested by the borrower.

To reiterate, till an advance is actually released by a bank and availed of by a borrower, until and unless an actual (fund based or fee based) liability is created, there is no advance (outstanding) in the books of a lender. When drafts or documents are purchased, that is an act of advancing by a bank. When an advance is given, money moves – from the lender to the borrower; an actual, tangible, specific, determinable, quantifiable liability is created. Where an LC is issued a clear liability, a risk exposure, comes into being. Capital adequacy requirements come into play. Hence, ‘purchase’ by the nominated bank can never be equated with a bank merely ‘agreeing to advance funds’. Where there is nothing but a mere “agreement to advance funds”, there is no risk exposure, the issue of recourse or non-recourse negotiation does not arise, there is no issue about paying back; Basel norms are not applicable. For similar reasons, I beg to differ with the observations of Glenn Ransier[iv] (“…so I agree, in writing, …etc.”) on negotiation.

If we accept the definition of ‘negotiation’ in Article 2, if we equate advancing funds with an ‘agreement to advance’, can a confirming bank (for example) – by simply agreeing to advance funds (at a future date) – said to have ‘negotiated’? Can we apply the term ‘without recourse’ to such ‘negotiation’ (agreement to advance)? Obviously not; but then the issue is, why not!

For reasons just stated, a mere agreement to advance, under no circumstances can be equated with an (outstanding) advance. The two are different things altogether. Therefore, I am unable to agree with Sheilar comments[v] that “…‘agreeing to advance funds’ should be deemed as another form of ‘purchase’.” A transaction that stops only at the stage of an agreement (to advance), short of the actual lending of funds, cannot be construed as ‘negotiation’ – whatever the circumstances.

(3)    “…on or before the banking day on which reimbursement is due to the nominated bank”:

I agree with comments[vi] by WangXuehui (Ofei) on this issue. Where the value date for both the receipt and the release is the same, a bank’s books will never show a liability or advance outstanding in its books. Where the negotiating bank “effects payment after receiving issuing bank’s cover” it is not advancing funds to the beneficiary; in reality paying out money that is actually the beneficiary’s own. Sheilar’s assumption[vii] that “that bank is still a negotiating bank provided that it has actually paid the beneficiary with its own funds”, therefore, appears misplaced. The transaction is absolutely no different from paying a drawer on the realisation of the proceeds of a documentary collection. Such a bank is not out of pocket, takes no risk, has no exposure, creates no ‘position’. The beneficiary has no liability or obligation towards the bank.

3. More confusion about ‘negotiation’

The UCP provisions on examination and forwarding of documents are as follows:

(a)  “Negotiation means the giving of value for draft(s) and/or document(s) by the bank authorised to negotiate. Mere examination of the documents without giving value (emphasis mine) does not constitute a negotiation.” (UCP 500, sub-article 10.b.ii).

Has this principle undergone a change in UCP 600? What should be defined as ‘giving value’?

(b)   UCP 600, sub-article 12(c), states: “Receipt or examination and forwarding of documents by a nominated bank that is not a confirming bank does not …. constitute honour or negotiation.”

(c) And now our favourite definition (Article 2 of UCP 600): “Negotiation means the purchase by the nominated bank of drafts (drawn on a bank other than the nominated bank) and/or documents under a complying presentation, by advancing or agreeing to advance funds to the beneficiary…etc.”

Does this “agreeing to advance funds to the beneficiary” come with any obligation or commitment on the part of the ‘negotiating’ bank? Are they really worth anything? For indications, refer to FAQ on UCP 600 by Gary Colleyer:

Question no. 2.15: “What are the consequences, if any, when a nominated bank negotiates documents and agrees to advance funds to a beneficiary but fails to do so on or before the banking day reimbursement is due to the nominated bank?”

Suggested answer: “A nominated banks give no undertaking to negotiate, unless they have confirmed the credit or communicated their agreement to act, on a without recourse basis – in accordance with sub-article 12(a). The fact that a nominated bank agreed to advance funds on a future date (i.e., on or prior to the date reimbursement was due) does not bind that bank to acting accordingly on the date the advance was expected or due (emphasis added).”

Clearly, such agreements or promises to advance funds, if they do not bind the bank and can be rescinded at will, are meaningless and should have no value. It would be foolhardy for a beneficiary to rely on such ‘promises’ to plan his cash-flow or his expenditure.

Yet, this nebulous ‘agreement’ makes all the difference to our definition of what ‘negotiation’ is. It is strange logic that a revocable promise or agreement to provide value (extent of exposure still indeterminate) on any future (but indeterminate) date earns itself the definition of ‘negotiation’ (Article 2). Whereas, sending the very same documents ‘on approval basis’, or for acceptance by the issuing bank (well before fund is provided to the beneficiary), does not. Note that in both instances the nominated bank does not transfer funds to the beneficiary, creates no liability. Yet, what distinguishes the two is a mere agreement without any binding commitment.

Oh, what a tangled web we weave…!

Let us examine another related issue, as follows:

1.    Let us imagine a situation where a bank “agrees to advance funds” and forwards documents as required by Article 15. Later, prior to the date when reimbursement is due, it rescinds the agreement. Is it still a ‘negotiation’ in the eyes of the UCP?

2.   According to Ofei[viii], “In China, many banks forward the documents to the issuing bank after examination of documents and credit the funds to the beneficiary’s account after they receive cover from the issuing bank.”

Should the foregoing be defined as ‘negotiation’ under the UCP? Not so, if we go by sub-article 12(c). Would an ‘agreement’ between the bank and the beneficiary make any difference; in what way does it matter to the issuing bank, anyway? However, if there is no negotiation (under sub-article 12.c), where does it place the issuing bank vis-à-vis the LC and the UCP?

3.   Allow me to refer to question no. 2.11 (FAQ on UCP 600 by Gary Colleyer): “An issuing bank accepts a complying presentation and communicates the maturity date to the nominated bank, post which the nominated bank negotiates. Is this covered under the current definition of negotiation?”

Suggested answer: “Article 2 refers to negotiation being the purchase of drafts and/or documents under a complying presentation. Sub-article 12(c) states that the receipt or examination and forwarding of documents by a nominated bank do not constitute negotiation. If, at the time of presentation, a nominated bank is not willing to act on its nomination, which in this case is to negotiate a complying presentation, then they should request the issuing bank in their covering schedule to authorise their negotiating on receipt of an advice from the issuing bank that documents have been accepted by them.”

[So, must we now introduce a new element, an authorisation from the issuing bank, to justify the delayed release of funds as negotiation under the UCP?.]

“…The definition of the term “Negotiation” suggests that it is to be made (whether in the case of an advance of funds or an agreement to advance funds) against the draft and/or documents…. As one cannot “purchase” a draft/documents which have already been sent to the issuing bank or have already been received by said bank or the applicant (emphasis added).” (Pavel Andrle, international trade finance consultant and trainer and Secretary of the Banking Commission of ICC Czech Republic)[ix].

In reality, banks do advance funds by passing entries after drafts/documents have been already been sent by them and are no longer in their physical possession. Although not clearly defined by the UCP, such practices are not against the banking laws of most countries.

The real issue is, can these (deferred) transactions be termed as negotiation? Article 15 (especially sub-article 15.c) does not say so.

4. Why an LC?

Primarily, an LC serves two distinct purposes. The first concerns the beneficiary’s performance under the credit, coupled with his aim to secure payment against certain risks; the issue is between the beneficiary and the issuing bank. The other, is to facilitate financing. This latter is a business decision, an arrangement exclusively between the beneficiary and the nominated (financing) bank.

With regard to the first, it is hardly of any concern to the issuing bank whether the nominated bank has negotiated or has agreed to advance funds. Whether banks agree to “advance funds to the beneficiary [on or] before the banking day on which reimbursement is due to the nominated bank”, negotiates, advances, purchases, provides a ‘finance umbrella’, gives overdrafts against export bills, pre-pays (sub-article 12.b), really makes no difference to the issuing bank or to the utilisation of a documentary credit. Its obligations under Article 7 – especially under sub-article 7(b) – continue. Frankly, the issuing bank is entitled to insert in the credit any stipulation that is within its authority. But matters on financing (barring Red Clause credits) are surely not one of them!

It should be the “beneficiary’s choice to obtain financing only on some determined future date due to their own practical reasons such as a liquidity arrangement and their own budget of funding cost (Sheilar[x])”. As Donald Kurtz[xi] says, “It is their business decision when, if, and how to purchase the drawing. …Is it the beneficiary who is asking his banker to purchase the drawing? That’s between him and his banker, including the w/ or w/o recourse issue”.

Regarding payment with or without recourse, this too is a matter between the nominated or confirming bank and the beneficiary. Adding confirmation, a nominated bank’s ‘obligations’ under sub-article 12.a etc. do not change the issuing bank’s obligations to the beneficiary under a documentary credit.

Hence, as Kurtz succinctly puts it[xii], “I am wondering what the problem is, and who it is that has the problem. It seems that the process is working fine.”

The problem is possibly with the ‘wordsmiths’ and of course, the UCP itself. Nguyen Huu Duc (Vietnam) suggests[xiii] that the expression ‘…on or before the banking day on which reimbursement is due to the nominated bank’ was added to UCP 600 Final Text September 2006, which was adopted by the ICC Banking Commission at their meeting in October 2006. I have a sneaky suspicion that last minute addition of the expression “…on or before the banking day on which reimbursement is due to the nominated bank” was to accommodate a situation where a beneficiary makes a complying presentation for negotiation, wants to take advantage of the LC and the UCP provisions, but requires (or asks for) no funds (call it a ‘non-funded’ negotiation, if you will).

Since the transaction is exactly as defined in sub-article 12(c), how is one to distinguish ‘mere examination and forwarding of documents’ (refer to comments of Ofei and T O Lee cited earlier) from ‘negotiation’?

5. Re-defining ‘Negotiation’

Combining the multifarious financing function of a documentary credit with its use purely as a payment mechanism in international trade into a neat little box called ‘negotiation’ – and drafting of the articles of the UCP to reflect that approach – is proving to be a nightmare for all concerned. As the foregoing analysis shows, the time has come to clearly distinguish between the utilisation of a documentary credit under the UCP by a beneficiary from its financing function.

Accordingly, I suggest the following:

1.  Let the term ‘negotiation’ continue in the lexicon of the UCP. (It has been there for far too long; may cause a serious withdrawal symptoms or hangover if dumped.) But, it should only define a complying presentation to a nominated bank under a documentary credit – irrespective of whether that bank finances against the documents presented, merely makes a promise, sends documents on approval basis or for acceptance (pending subsequent advancing of funds to the beneficiary), pre-pays etc. Every aspect of financing should be left to the borrower and the lender, to be determined by their respective countries’ laws, norms, procedures and practices.

2. The magic word ‘negotiated’ or ‘negotiation’ must find a place on the forwarding letter (covering schedule) of the nominated bank, which must indicate thereon that the documents have been negotiated under a particular credit number of the issuing bank.

Suggested revised definition of ‘negotiation’:

"Negotiation means the complying presentation of drafts (drawn on a bank other than the nominated bank) and/or documents to a nominated bank, and its declaration on its covering schedule that it has negotiated against a particular documentary credit of the issuing bank."

Where a confirming bank negotiates, sub-article 8(a)(ii) – among others – should continue to apply. For the banks that have not confirmed a credit, the matter of recourse payment or payment under reserve should be left exclusively to the nominated bank and the beneficiary. (Every bank that lends to its borrower-clients, including to the beneficiary of a credit, anyway legally binds the borrower against possible default in repayment, non-payment or non-realisation of advances granted to it.)

The term ‘reimbursement’ is supposed to be used only by a bank that is already out of funds (having made an advance). An option is to use the term under all circumstances where a claim is made under an LC. The alternate is for the negotiating bank to ‘claim reimbursement’ (if it is out of funds prior to its claim), or ‘claim realisation/payment’ (where it is not out of funds).

Through a suitable worded article, the UCP may clarify that its provisions do not stand in the way of financing arrangements between institutions (including banks) and prospective borrowers, whether against LCs or drafts/shipping documents. This reiteration may help avoid inconvenience to the parties in a documentary credit transaction and legal issues.

6. Advantages from the revised definition

I expect that, following the revised definition of the term ‘negotiation’, the following issues should stand resolved:

1.     Definition of ‘negotiation’ in Article 2: A nominated bank honours or pays without recourse against drafts/documents drawn on it – unless it pays under reserve. The UCP is silent on this aspect.

2.      Definition of ‘negotiation’ in Article 2: Here, negotiation is equated with purchase. In reality, it is not so.

3.      Definition of ‘negotiation’ in Article 2: The fact that ‘agreeing to advance funds’ has been equated with an outstanding advance.

4.     Definition of ‘negotiation’ in Article 2: The assertion that ‘agreeing to advance funds to the beneficiary on … the banking day on which reimbursement is due’ is an advance.

5.      Whether advancing of funds – well after the documents have been despatched, or after the issuing banks approves of or accepts the documents presented – before the value date of reimbursement can be termed as ‘negotiation’ within the meaning of the UCP.

6.     Sub-article 12(a): A confusing, if not meaningless, reference to ‘obligation’ of “the nominated bank to honour or negotiate, (where it has) expressly agreed to (do so) and communicated (accordingly) to the beneficiary”. Further, the ‘obligation’ is not the same as that of a confirming bank, though a general reading of the sub-article points to an erroneous conclusion. The ‘express agreement’ is purely an arrangement between the negotiating bank and the beneficiary; it has nothing to do with the utilisation of a credit. This sub-article should be deleted.

7.    Sub-article 12(b): Advancing of funds to a borrower/beneficiary in any manner whatsoever, is not something that the issuing bank or the applicant should be concerned with. Additionally, this sub-article, if retained in its present form, could have serious implications – as pointed out by Sheilar T. Shaffer[xiv]. The revised definition of ‘negotiation’ should resolve the anomalous situation.

8.   Sub-article 12(c): The interpretation of mere “receipt or examination and forwarding of documents by a nominated bank…” and the resultant confusion and contradictions with other provisions of the UCP would no longer exist.

9.     Para 2 of Article 35: The section “If a nominated bank determines that a presentation is complying and forwards the documents to the issuing bank or confirming bank, whether or not the nominated bank] has honoured or negotiated,…” can be simplified further.

10.   In the whole of the UCP, payment ‘without recourse’ finds mention only against sub-article 8(a)(ii). Yet, the issue is closely linked with expressions such as honour, (to) pay, obligation, express agreement, drafts drawn on the nominated bank, and so on. Strangely, nowhere does the UCP provide clarity or guidance on ‘recourse’ payment in the context of the aforementioned expressions. The issues, therefore, continue to remain as confusing as ever.

A few articles of the UCP would have to be modified to reflect the changes on the lines suggested.

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