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.

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