Tuesday, April 30, 2013

Wanted: A more positive article 15

Wanted: A more positive article 15[1]

The expressions “reasonable time” and “without delay”, because of their non-specific nature, came under intense scrutiny during the drafting of UCP 600. “Without delay” survived, but the appearance of the expression “reasonable time” in sub-article 13(b) of UCP 500 was to be its last. The latter was removed completely from UCP 600. Five years on, few seem to feel its absence.
“Without delay” conveys a greater sense of urgency than “reasonable time”. “Reasonable time” stretches the permitted time to an outer limit that could perhaps be justified under a given circumstance. Yet, both of the expressions are subjective in nature; neither indicates any definitive time frame nor a globally acceptable standard. It’s debatable whether any period could, in all fairness, be set as a “reasonable time”. Hence, it could not be part of any internationally applicable rules. If considered from a technical or legal point of view, a definite number of days was desirable. But even in its absence, most people preferred clear definitions and guidelines, black-and-white solutions over stipulations that were indefinite or vague in nature. A definite period was easier to handle. Compliance, or its breach, was easier to determine.
“Without delay”
The term “without delay” posed similar problems. A few members of the UCP 600 Drafting Group felt that the term should be disregarded, as were similar terms in the UCP such as “immediately” and “as soon as possible”. This was because, like “reasonable time”, “without delay” did not specify a definite period. Finally, it was decided to live with the expression, with the expectation that banks would act in accordance with the intent with which the words were used, i.e., expeditiously. In the final version of UCP 600, the expression “without delay” appears in six places.
The demand for setting a fixed number of days had its opponents. They insisted that the reason for having retained “reasonable time” in the UCP was because not every situation or circumstance could be envisaged in advance, rigidly defined or put in a straightjacket. The variety of credits was considered to be too complex. The inclusion of these expressions was said to convey a sense of responsibility and accountability. One view was that if the concept of “reasonable time” were removed, a bank might not take the initiative to examine the documents presented and to pay well before the maximum period allowed under a credit. The expression “reasonable time”, they claimed, saved bankers from having to justify to either party why the applicant had to part with the funds earlier than the maximum period allowed, or why it took more than a day or two to honour the documents presented.
Thus, the UCP 500 expression “shall each have a reasonable time, not to exceed seven banking days” allowed some leeway, with a built-in safeguard by way of a cap regarding the outer limit for the examination of documents. From the revised UCP 600 expression “shall each have a maximum of five banking days” (emphasis added), it could appear that ICC was not reducing the time from seven to five banking days; instead, it might be claimed that  the available time was only being increased from a shorter time frame (guided by the circumstances of each case and practical considerations) to five days under the new UCP.
Even so, the majority of the Banking Commission members desired clarity. When the issue came up for a vote at the June 2005 Dublin Meeting of the Commission, all except one country voted for the removal of all references to the words “reasonable time”. This made life easier for the Drafting Group, though the late Ole Malmqvist wrote: “For the Drafting Group, that was a nice clear decision, but I wonder if that change will lead to a general delay in payments to beneficiaries. If it does, we trade finance bankers will regret that we deleted it, and in a few years – fewer than if we retain the “reasonable time” concept – we will have plenty of time to wonder why we did it.”
Further steps
In addition to doing away with the undefinable concept of “reasonable time” in favour of a fixed number of days, The Drafting Group went a step further. It wrote into the rules a new article , article 15, titled “Complying presentation”. This article states in clear terms what, until then, had been confined largely to considerations of “international standard banking practice”. The new article now sought to delineate the responsibilities of a nominated bank, a confirming bank and an issuing bank on receipt of a complying presentation. Whether article 15, as it stands today, helps to add any value, any new dimension or rule to the existing practice, is debatable. The fact remains that the Drafting Group, in its wisdom, found it necessary to identify and to close a perceived gap in documentary credit procedures.
Any modification to the rules which helps to remove grey areas is always welcome. From that standpoint, although “without delay” remains, deletion of “reasonable time” was as welcome as the addition of Article 15 to the rule book. The insertion of Article 15 in the UCP is an instance of not relying wholly on international standard banking practice (yet another vague expression), but making the rules more specific.
A “black hole”?
What puzzles this writer is the reason why the Drafting Group did not take the provisions of Article 15 to their logical conclusion. While they went to considerable lengths to eliminate and replace vague, non-specific phrases, they appear to have left a procedural “black hole” in Article 15.
Sub-article 15(a) states: “When an issuing bank determines that a presentation is complying, it must honour.” Quite so! But the question is “When, within how many days?” What’s the point of creating a so-called rule to tell the issuing bank that it must honour (nothing new there; the issuing bank is already bound by Article 7 to do so), but stop short of stipulating a reasonable time for the same?
A similar question arises with regard to sub-article 15(b). It states: “When a confirming bank determines that a presentation is complying, it must honour or negotiate and forward the documents to the issuing bank.” Apart from the matter of forwarding documents, this sub-article simply repeats a section of sub-article 8(a). The confirming bank is under no obligation or compulsion to negotiate within a “reasonable time” (similar to the issuing bank), or to forward the documents “without delay” to the issuing bank.
Sub-article 15(c), the last in the trilogy, is stranger still. It states: “When a nominated bank determines that a presentation is complying and honours or negotiates, it must forward the documents to the confirming bank or issuing bank.” Nothing unique here. It’s acknowledged that a nominated bank is under no obligation to negotiate even if a presentation is complying. But what about its obligation to the presenter to either negotiate or to return the documents – all within a reasonable time, without delay? Is this too much to ask?
A remedy
Sub-article 7(c) begins with the sentence, “An issuing bank undertakes to reimburse a nominated bank that has honoured or negotiated a complying presentation and forwarded the documents to the issuing bank.” The absence of any mention of “reasonable time” or “without delay” here is not only perfectly acceptable and logical, but also eminently desirable. However, the issuing bank could face difficulty in refusing to honour or pay against reimbursement claims received after considerable delay (e.g., documents negotiated subsequent to a complying presentation, but received by the issuing bank, say, one or two years after the expiry or cancellation of a credit). In case of such refusals, the issuing bank has no protection today under the UCP. Under article 7.b, the issuing bank is “irrevocably bound” by its undertaking to honour. This undertaking is open-ended; it provides for a last date only for the presentation of documents (article 6), but none whatsoever for its expiry. Tweaking Article 15 provides an opportunity to remedy this situation.
In its present form, Article 15 hardly states anything that has not been stated elsewhere in the UCP. What it fails to do is spell out the obligations of the banks as conclusively as possible. For the reasons stated here, Article 15 should be taken to its logical conclusion by adding either “reasonable time” or “without delay” to each of the three sub-articles. This would add a positive, decisive thrust to the rules and underscore the reason why “reasonable time” in the UCP was replaced in the first place with a definite period of time.

[1] Published: DCInsight, Page 10, Vol 18, No. 4, October-December 2012.

Thursday, April 25, 2013

Redefining 'negotiation'

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.
Ole Malmqvist, a member of the UCP Drafting Group for UCP 600 says, 
.... 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.”
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’s comment[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.
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, however is, can these (deferred) transactions be termed as negotiation? Article 15 (especially sub-article 15.c) does not say so.
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’?
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:
¨   Let the term ‘negotiation’ continue in the lexicon of the UCP. (It has been there for far too long; more than 70% of the LCs issued globally are negotiation credits; 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.
¨   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 documents – with or without being accompanied by drafts (drawn on a bank other than the nominated bank) – to a nominated bank, and the latter’s declaration on its forwarding letter 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.
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.

Selected articles of the UCP would have to be revised to reflect the changes on the lines suggested.

[i] DCInsight, April-June 2004.
[ii] LC Monitor-Trade Services Update, Volume 11, Issue 2, March–April 2009.
[v] Ibid.
[vi] Ibid.
[vii] Ibid.
[viii] Ibid.
[ix] DCInsight, Vol 15, No 3, July-September 2009.
[x] LC Monitor-Trade Services Update, Volume 11, Issue 2, March - April 2009.
[xi] Another comment on ‘Negotiation, Trade Services Update Volume 12, Issue 3, May – June 2009.
[xii] Ibid.
[xiii] LCM-Trade Services Update, Volume 11, Issue 2, March - April 2009.
[xiv] DCInsight, Vol 15 No 3, July-September 2009.

Nominated bank and UCP 600

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:  
  1.  An issuing bank may authorise a nominated bank to honour or negotiate (under its own credit).
  2.  Such authorisation casts no obligation (to honour or negotiate) on a nominated bank that has advised the credit to the beneficiary. 
  3.  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).
  4.   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).”[i]
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 construction, 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.

[1] Published in DC Insight, Volume 17, No. 1, Jan-March 2011.
[1] Author is the former managing director of Fina Bank Ltd, Nairobi, Kenya and TransAfrica Bank  Ltd., Kampala, Uganda; founder and CEO of Institute of Banking Studies.  

[i] ‘Suggested answer’ to question no. 2.15, Frequently Asked Questions on UCP 600, Gary Collyer.

Wednesday, April 24, 2013

Article 12, UCP 600 - a critical analysis

Ever since UCP 600 was published, Article 12 (Nomination) each of the three sub-articles provided room for confusion about their intent and purpose. This article examines the issues related to Article 12 as a whole, taking up one sub-article at a time.

Sub-article 12(a)
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.”
This sub-article addresses two distinct effects of nomination. The first is a nominated bank’s obligation, if any, to honour or negotiate upon being nominated. The second is an apparent exception to the foregoing. The first part of the sentence stipulates that, unless the nominated bank confirms the credit, its nomination by the issuing bank casts no obligation on the bank thus nominated to honour or to negotiate. This is perfectly correct, and is also in accordance with Article 8. This is not a rule, but more in the nature of a clarification; however, its existence helps. The problem is with the second part of this same sentence or sub-article. The expression “except where expressly agreed to…” appears to provide for an exception to what goes before it. One would, thus, be led to believe that the obligation to honour or negotiate is indeed cast on the nominated (non-confirming) bank, provided that bank ‘expressly agrees’ (to negotiate or honour) and communicates the same agreement or willingness to the beneficiary.

As we know, this sub-article intends no such thing, rather just the opposite. Further, it should be noted that such (so-called) express agreement can be revoked, cancelled, or reneged upon any time thereafter. As far as obligation to honour or to negotiate is concerned, there is no difference whatsoever between (a) a non-confirming nominated bank that advises without expressing any willingness, and (b) a nominated bank that expressly agrees to honour or negotiate and communicates the same to the beneficiary. In both the instances, the nominated bank (not being a confirming bank under Article 8) enjoys exactly the same privilege and protection under the UCP.

The so-called express agreement communicated to the beneficiary to honour or to negotiate, could, at best be considered as some sort of "silent confirmation". Everything about "silent confirmation" is outside the UCP. 

What exactly, then, is this sub-article 12(a) trying to achieve? What value does it add to the UCP? Since it only creates confusion, is there any need for the second part of this sub-article to be there at all in UCP 600?

Sub-article 12(b)
It is no big secret that sub-article 12(b) was inserted in response to the Banco Santander case. The impact of this new provision in the UCP is yet to be tested in a court of law. The fact is, the “authorisation” referred to in this sub-article is irrelevant, inconsequential, and adds nothing to the appraisal process of any advances proposal of a lending bank. In an article[i] published in this journal I had written that, “unless the ‘authorisation’ referred to in sub-article 12(b) implies 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).”

I am encouraged by the well-argued article “Banco Santander and protected parties” by Prof. John F. Dolan, published in DCInsight (Vol 17, No. 4, October-December 2011). He concludes, “…parties seeking the answer to the question of the DPU holder’s freedom from the fraud defence should look to the law, not the UCP and not to practice or issuer’s mandate (emphasis added)”. I cannot agree with his reasoning or his conclusions more. “Pre-payment” is a financial arrangement between the bank incurring the DPU and its customer – the beneficiary of the facility. The UCP has nothing to do with it. Incidentally, one should remember that banker’s acceptance is governed, and protected, by the Bills of Exchange Act or similar legislations enacted to deal with negotiable instruments. The DPU is not a negotiable “instrument”; consequently, it does not enjoy similar protection.

I fear that, if and when this sub-article 12(b) is put to the test, it is likely to fall short of the expectation raised by it, and fail to protect the parties seeking protection under it. If the DPU holder is not a “protected party” in a fraud situation, then sub-article 12(b) of UCP 600 fails in its purpose – irrespective of any so-called “authorisation”.
Till a rethink takes place on the utility of this sub-article, some rephrasing may be in order. The last part of this sub-section could be modified to read as follows, “…that nominated bank to discount an accepted draft or advance against a deferred payment undertaking incurred by that nominated bank”. In everyday commercial banking lexicon, an acceptance draft is always discounted, not “purchased”. The term “prepay” is ambiguous, its precise meaning debatable – hence this term is better replaced.

Sub-article 12(c)
This sub-article stipulates that,
“Receipt or examination and forwarding of documents by a nominated bank that is not a confirming bank does not … constitute honour or negotiation.”
The sub-article appears not to be a rule but an explanatory note to the definition of negotiation appearing under Article 2. One would have hoped that this sub-article would clarify what already is a hotly debated expression. Unfortunately, it fails to do so, for the following reasons.

During any act of negotiation (or honour) a non-confirming nominated bank interacts at two levels. At one level, it’s with the beneficiary; at another, with the confirming or the issuing bank. After negotiation or honour, in accordance with sub-article 15(c), “it must forward the documents to the confirming bank or issuing bank.” The UCP does not state how exactly the recipient bank would determine whether a negotiation has indeed taken place. Although this omission has not hindered documentary credit operations worldwide, incorporation of the following from a recent DOCDEX decision[ii] would have been helpful. It states,
“A nominated bank that has negotiated a complying presentation should expressly indicate on its document remittance schedule that it has negotiated the documents. However, the absence of such indication does not violate UCP 600. The omission does not affect the nominated bank's status as negotiating bank, nor does it discharge the issuing bank's payment obligations as long as the nominated bank confirms its negotiation to the issuing bank.”[iii]
The other operational aspect relates to the nominated bank vis-à-vis the beneficiary. According to sub-article 12(c), mere examination and forwarding of documents by a (non-confirming) nominated bank does not constitute negotiation. If not, then what does? I would have answered this question by invoking UCP 500, Article 10(b)(ii), which stated:
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 does not constitute a negotiation (emphasis mine).
However, with UCP 600 in hand, I stumbled at the definition of negotiation (Article 2), which states, inter alia, that,
“Negotiation means the purchase … or agreeing to advance funds to the beneficiary on or before the banking day on which reimbursement is due to the nominated bank.”
Such agreement is non-obligatory, is revocable in nature, and is not binding on the negotiating bank. Since no consideration passes between the parties concerned on merely “agreeing to advance funds to the beneficiary”, one wonders if the principle of giving value been done away with in UCP 600.

On the one hand, receipt or examination and forwarding of documents do not constitute honour or negotiation (sub-article 12.c). On the other hand, a mere (revocable) agreement to advance funds – coupled with “receipt or examination and forwarding of documents” – where no consideration or value is passed on, is defined as negotiation. Sub-article 12(c) appears to conflict with the definition of negotiation appearing in Article 2. Given this contradictory situation, what does constitute negotiation[iv]? Giving of value would have been a good yardstick, but, is it any more? Short of any credit to his account, when precisely can the beneficiary conclude that his documents have indeed been negotiated? This sub-article is, therefore, neither here nor there, serving no definite purpose!

Incidentally, it would be illuminating to know the number of instances in real life when a nominated bank has actually negotiated by simply “agreeing to advance funds to the beneficiary”.

In the construction of this sub-article several errors have crept in. These are as follows:
  1. 1.   “Receipt” of documents must obviously precede their examination and forwarding; it need not be stated in so many words. Since it serves no purpose, ”[R]eceipt or” should be deleted.
  2. 2.   In the section, “…is not a confirming bank does not make…” the word “does” should be replaced by “do”.
  3. 3.   In “nor does it constitute honour or negotiation”, the words “does it” should be replaced with “do they”.
  4. 4.  Finally, of the three distinct acts of receipt, examination and forwarding, it should be made clear as to which of the three – all three together, or any of the three – the pronoun “it” (in “does it constitute”) refers to.

Except the first part of sub-article 12(a), what precisely are we left with, then? Is it the second part of sub-article 12(a) – which adds no value? Or sub-article 12(b), which is a misplaced and possibly erroneous interpretation of the Banco Santander case – a sub-article that is yet to be tested in a court of law, one which may possibly be projecting a false sense of security in a fraud situation? Or, is it sub-article 12(c), which is not only confusing and poorly drafted, but falls short of any precise and positive contribution to the UCP, directly contradicting the definition of “negotiation” under Article 2. You be the judge!

[i] Nominated bank and UCP 600, DCInsight, Volume 17, No. 1, Jan-March 2011.
[ii] “Issues in UCP 600: another look at five banking days and negotiation” by King-Tuk Fung, DCInsight, Vol. 16, Issue 1, October-December 2009.
[iii] That confirmation may be on the forwarding schedule itself or through later communication.
[iv] Negotiation and the law of contracts, DCInsight, Vol. 16, No. 2, April-June 2010, and Re-defining Negotiation, LC Monitor-Trade Services Update, Volume 11, Issue 4, July–August 2009.