Wednesday, April 24, 2013

Some random thoughts on the UCP


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[i]. 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)[ii]. 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:
  1. 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.”
  2. Section 9: “In so far as the proposal or acceptance of any promise is made in words, the promise is said to be express….”.
  3. Sub-section 2(c): “The person making the proposal is called the "promisor” and the person accepting the proposal is called the “promisee".
  4. 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.”
  5. Sub-section 2(e): “Every promise and every set of promises, forming the consideration for each other, is an agreement.”
  6. Sub-section 2(h): “An agreement enforceable by law is a contract.”
  7. Article 14(1), Part II (titled Formation of the contract) of the CISG states,
  8. 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.”[iii]
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 in the CISG reflect 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[iv], 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[v] 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[vi], 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[vii].
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[viii], 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[ix]. 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: The term is used for non-LC bills, when a bank advances funds against instruments payable on demand i.e. at sight or immediately on presentation. Through this act, after having paid consideration to the holder, the bank acquires ownership rights over the instrument.
(b)   Discount: The expression is applied in the context of usance bills (acceptance bills). In conformity with the Bills of Exchange Act or the N. I. Act, a usance draft is necessary for acceptance by the drawee – before or after discounting. A discounted value against future receivables (hence the origin of the term) of the bill of exchange is advanced to the holder.
(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:
  1. An expression to define advancing (pre-paying?) funds against documents presented under credits available by sight payment.
  2. A single expression to define advances made against future receivables, where documents are presented under credits available by acceptance (a) to the drawee, or (b) to a bank other than the drawee bank.
  3. 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”[x]. 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? [xi]
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.[xii]
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’[xiii], 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[xiv] 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[xv]:
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.



[i] Negotiation and the laws of contract, DC Insight, Vol. 16, No. 2, April-June 2010.
[ii] Issued by the United Nations Commission on International Trade Law, United Nations, New York, 2010.
[iii] Articles 15(2) and Article 16 of the CISG reflect similar approach to revocation.
[iv] Does this provide grounds enough for modifying Articles 2 and 4 of the ISBP to create a level playing field?
[v] The expression ‘promisee’, describing the issuing bank - the original promisor or proposer – in this particular context, is derived from the title to Section 52 viz., “Order of performance of reciprocal promises”, and sub-section 2(e) of the ICA (“Every promise and every set of promises, forming the consideration for each other…”.
[vi] “…Silence or inactivity does not in itself amount to acceptance”, states Article 18(1) of the CISG.
[vii] ICC Official Opinion R520 / TA543 rev2 - Unpublished Opinion 1995-2004.
[viii] DC Insight, Vol. 17, No. 1, Jan-March 2011.
[ix] An agreement, valid in law, is defined as a contract. In places, I have used the terms interchangeably for the limited purpose of this article.
[x] Article 3 of the Uniform Rules for Collection, ICC Publication No. 522.
[xi] Refer to my articles Negotiation and the law of contract, DC Insight, Volume 16, Issue 2, April-June 2010, and Re-defining negotiation, LC Monitor-Trade Services Update, Volume 11, Issue 4, July-August 2009.
[xii] This appears to be a deviation from the principle stated in UCP 500, sub-article 10(b)(ii) which read as follows: “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 added)”
[xiii] The definition in Article 2 of UCP 600 is full of holes. After the publication of my article Re-defining negotiation, in the LC Monitor-Trade Services Update, Volume 11, Issue 4, July-August 2009, I was hoping to receive very strong, specific, point-by-point rebuttal of the points I had made therein. Surprisingly, I have received absolutely none till date. (Incidentally, has anyone ever wondered why, since the first UCP was released in 1933, the term “negotiation” has defied a universally acceptable definition?)
[xiv] Review of the recent Swiss Supreme Court decision (Emirates Bank International v. Credit Lyonnais (Suisse) S.A., Decision 1 June 2004, Tribunal Federal) on deferred payment credit from a comparative commercial law perspective, Chang-Soon Thomas Song, 10 May 2005.
[xv] Sub-article 12(b) was inserted in UCP 600 to address the issues raised by the courts on deferred payment credits.
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