Sunday, May 19, 2013

Pre-payment, honour and bills of exchange


INTRODUCTION[i]
The terms honour and pre-payment were introduced to documentary credit operations for the very first time through UCP 600. The intended meaning of “pre-pay” appearing in article 12(b) has defied interpretation since its introduction and caused quite some confusion. A recent query on “pre-pay” and related issues came to the fore in the form of the following query on another forum. The query, presented in two parts, was as follows:
“Situation One
LC available with the confirming bank by acceptance; draft to be drawn on the confirming bank. Tenor of the draft: 120 days from the date of bill of lading. Additional condition: Despite the tenor of the draft being 120 days from the date of B/L, the confirming bank may discount the bill upon receipt of complying presentation at its counter and pay the beneficiary at sight. Discounting charge and confirming fee are on applicant's account.
Upon receipt of documents, confirming bank decided that the documents constituted a complying presentation. It discounted the bill as per credit stipulation and forwarded the documents to the issuing bank.
Issues:
1.     Is the discounting function of the confirming bank equivalent to "honour" as defined in the UCP?
2.     If not, what other function remains pending at the counter of the confirming bank in order to term the transaction for having met the definition of "honour" (Article 2 of UCP 600)?
Situation Two:
LC available with the issuing bank by acceptance; draft to be drawn on the issuing bank. Tenor of the draft is 120 days from the date of bill of lading. Additional condition: Despite the tenor of the draft being 120 days from the date of the B/L, issuing bank may discount 60 per cent bill value upon receipt of complying presentation at their counter and payment made to the beneficiary at sight. Discounting charge and confirming fee are on applicant's account.
Upon receipt of documents, issuing bank decided that documents constituted a complying presentation. It discounted the bill for 60 per cent of face value as per credit stipulation.
Issues:
1.     Is the discounting function of the issuing bank equivalent to the "honour" function defined in Article 2 of the UCP?
2.     If not, what other steps remain to be completed by the confirming bank in order to term the transaction as having complied with the definition of "honour"?”
ANALYSIS
In Article 2 of UCP 600 the term “honour” has been defined as follows:
a.   to pay at sight if the credit is available by sight payment.
b.  to incur a deferred payment undertaking and pay at maturity if the credit is available by deferred payment.
c.   to accept a bill of exchange (“draft”) drawn by the beneficiary and pay at maturity if the credit is available by acceptance.”
Important points to be noted are as follows:
1.     Under the UCP, for a transaction to be defined as “honour”, payment must be made only when it is due – “at sight”, or “at maturity” – not earlier.
2.     The operations of bills of exchange are governed by certain statutory enactments by the countries concerned. Reference may be made to the Bills of Exchange Act 1882, UK, the Negotiable Instruments Act 1881 (India), the Czech Bill of Exchange and Cheque Act No. 191/1950 (“BECA”), Negotiable Instruments Law of the People's Republic of China (1995, revised in 2004). Although these enactments are somewhat similar in their basic structure, they do differ in detail.
3.     The question has used the term “discount”. In normal banking parlance this term is used to describe an advance against usance bills that are not yet matured for payment, by a bank that is neither the drawee nor the acceptor of the usance draft that, by definition, accompanies usance bills. While on the subject, let me also say that “purchase” is the term used by banks to define an advance by them against demand bills only (not usance bills). Incidentally, discount or purchase is generally (but not always) with recourse, since few banks would like to advance funds leaving itself with no option to reclaim in case of default or non-realisation of the underlying asset.
Problem areas
There would have been no problem in answering the above questions had not the bank that (so-called) “discounted” the bills also been the drawee or the acceptor of the bills of exchange. It would then have been a simple case of a nominated bank advancing funds to the beneficiary (a risk exposure), pending reimbursement in accordance with UCP 600 Article 7(c).
But the issues that this question throws up are a bit more complex. Let me address the issues one at a time.
Issue One
The credits, under “additional condition”, state that the confirming bank or the issuing bank, as the case may be, may discount the bill (for full value or 60% of value, respectively) upon receipt of complying presentation at its counter and pay the beneficiary at sight.
This stipulation appears to be in line with Article 12(b) of UCP 600, which states that, “By nominating a bank to accept or incur a deferred payment undertaking, an issuing bank authorizes that nominated bank to pre-pay or purchase a draft accepted or a deferred payment undertaking incurred by that nominated bank.” The main issue, however, is: by making this “additional condition” an integral part of the credit, is the issuing bank offering to underwrite the advance, it being a risk exposure of the (nominated) lending bank? Would the nominated bank be protected by the issuing bank if the funds cannot eventually be recovered from the beneficiary? Would the nominated bank take the implication of this “additional condition” into consideration while taking a credit decision – to discount or not to discount? If the answer to all these three questions is “no”, then of what use or relevance is this so called “authorization” that Article 12(b) speaks of?
Issue Two
The second is within the domain of the BoE Act, howsoever named by the country concerned. We are aware that the act of “acceptance”, once completed, is without recourse. Which makes it evident that the payment that consequently follows is inevitable, a natural corollary, and is also without recourse. Common sense tells me that the drawee/acceptor must pay when payment is due, or default in payment on maturity. The critical question here is, how is one to define payment to the beneficiary by the (nominated) accepting bank when it “discounts”? Is it an advance, to be repaid later by the receiver (beneficiary)? Is it in the nature of final payment/settlement (without recourse) by the accepting bank, effected before (earlier to) the original date of maturity of the bill? Is a drawee of a bill of exchange, its acceptor, permitted by the Act to discount its own acceptance? More importantly, are such payments permitted by the law of the land?
Issue Three
A section of Article 12(b) uses the expression “to pre-pay or purchase a draft accepted or a deferred payment undertaking incurred by that nominated bank”. We know what “purchase” means. But this sub-article is referring to instruments payable not on demand but only at a future date. Should we, then, infer simply by association that “pre-pay” is synonymous with “discount”? That it does not imply final settlement earlier to the date of maturity? Either way, we have to go back to Issue One or Two for answers.
Issue Four
Let us assume “discount” or “pre-payment” to indicate an advance to the beneficiary, not partial or full settlement of dues originally payable on maturity. Then too we land ourselves in a peculiar situation. When the date of maturity date comes around, should the accepting bank recall the advance on the one hand, and pay the same amount once again to the beneficiary as per the original terms of acceptance, just so that the letters of the law, viz., “payment in due course” are complied with? If it does not do so, would it be exposed to claims from the beneficiary for non-payment on due date in accordance with the terms of its original acceptance?
This question may sound peculiar, or go against common sense. The provisions of the BoE Act of the country concerned could, possibly, serve as a guide. Let us first quote from and then examine a few of them.
(1)   BoE Act 1882, UK
Section 59: Payment in due course (Discharge of Bill)
Section 59.1: A bill is discharged by payment in due course by or on behalf of the drawee or acceptor.
“Payment in due course” means payment made at or after the maturity of the bill to the holder thereof in good faith and without notice that his title to the bill is defective.
(2)   Negotiable Instruments Law of the People's Republic of China (1995, Revised in 2004).
Article 58: If a payer makes the payment before the due date for draft payable on a fixed date or on a fixed date after the date of draft or on a fixed date after sight, the payer shall bear the responsibilities arising therefrom on his own.
Article 60: After the payer has paid the draft amount in full, the liabilities of all debts shall be relieved.
(3)   Bill of Exchange and Cheque Act No. 191/1950 (“BECA”) of Czechoslovakia.[iii]
Section 40:
(1) The holder of a bill of exchange cannot be compelled to receive payment before maturity. (2) The drawee who pays before maturity does so at his own risk. (3) Who pays at maturity is validly discharged, unless he has been guilty of fraud or gross negligence. He is bound to verify the regularity of the series of endorsements, but not the signature of the endorsers.
(4)   Negotiable Instruments Act 1881 (India)
Section 10. "Payment in due course"
“Payment in due course" means payment in accordance with the apparent tenor of the instrument in good faith and without negligence to any person in possession thereof….
Three distinct points that emerge, which are as follows:
(1)   The acceptor is not obliged to pay before maturity.
(2)   The acceptor is validly discharged (only?) when he pays at maturity, defined as “payment in due course”.
(3)   Payment prior to the date of maturity is not specifically prohibited, but such payment is at the payer’s risk.
[Henceforth, wherever mentioned, “Bill of Exchange Act” will imply enactments of similar nature as adopted by the country concerned.]
Issue Five
Let us for a moment revert to the original the query and the question asked, “Is the discounting function of the confirming bank equivalent to "honour" as defined in the UCP?” Strictly speaking, the answer ought to be in the negative, for the reason that such payment (discount) was not “at maturity” (Article 2). But this gives rise to the dilemma posed in the next question, “If not, what other function remains pending at the counter of the confirming bank in order to term the transaction for having met the definition of "honour" (Article 2 of UCP 600)?” None, possibly, since settlement (in full) has already been effected. Only reimbursement would be awaited from the issuing bank as per Article 7(c). Having received payment – assuming, with mutual consent – the beneficiary should have no cause for action against the drawee.
Regulatory requirements
In addition to the provisions contained in the Bills of Exchange Act, a bank desiring to pre-pay may also have to comply with other country-specific statutory or regulatory requirements. In India, for example, the Reserve Bank of India, the central bank of the country, in its Master Circular[iv] on “Import of Goods and Services” stipulates as follows:
“Section C.2.: Interest on Import Bills
(ii) In case of pre-payment of usance import bills, remittances may be made only after reducing the proportionate interest for the unexpired portion of usance at the rate at which interest has been claimed or LIBOR of the currency in which the goods have been invoiced, whichever is applicable. Where interest is not separately claimed or expressly indicated, remittances may be allowed after deducting the proportionate interest for the unexpired portion of usance at the prevailing LIBOR of the currency of invoice.”
Article 12(b)
When we examine Article 12 UCP 600, we come across several flaws, of which we deal with only sub-article 12(b). The reasons why ICC ought to reword Article 12(b) are as follows:
a)     “By nominating a bank to accept or incur a deferred payment undertaking,…”: One cannot accept …a deferred payment undertaking; the word “accept” relates only to a usance bill of exchange and is well defined in the Bills of Exchange Act.
b)    The words “or purchase” should be deleted from the section “…authorizes that nominated bank to pre-pay or purchase a draft accepted or…”. The term “purchase” applies only to instruments payable on demand, definitely not to acceptance drafts or to deferred payment undertakings.
c)     “…authorizes that nominated bank to pre-pay or purchase a draft accepted or…”: The term “pre-pay” should be replaced with “discount”. Until and unless it is clearly defined by the UCP, pre-pay is as yet an ambiguous term, hence best avoided.
Conclusion
Neither Article 12(b) nor any other article of the UCP provides for purchase or pre-payment by the issuing bank. A casual reading of Article 12(b) will show that pre-payment applies only to a nominated bank; not by any stretch of imagination to the issuing bank. Therefore, the incidence of an issuing bank discounting (as distinct from pre-paying) its own obligation should not arise.
If we accept the above argument, where an LC permits or authorises pre-payment, such pre-payment may possibly be made by a bank that is not the drawee bank. Even so, the terms of the LC cannot be above the law of the land. A few experts have introduced matters of pre-payment “with recourse” or “without recourse”. Such arguments lead one to wonder how a nominated drawee bank that has accepted drafts drawn on it can possibly effect pre-payment with recourse.
The ICC has excluded, with good reason, instances of “pre-payment” (payment before maturity) from its definition of “honour”. The term “pre-payment”, which implies payment by the drawee/acceptor prior to maturity of the underlier, appears to be out of the purview of the Bills of Exchange Act, being a matter of mutual agreement and consent. Only the applicable law or judicial pronouncements can tell us whether such pre-payments, i.e. payment in advance of maturity date, could be deemed as equivalent to “payment in due course” in its legal implication, or relieve the drawee/acceptor of all liabilities and debts.
Given the variation in the regulatory framework and the provisions of the Bills of Exchange Act (howsoever named) from one country to another, generalisation could be risky. The interpretation and inference would necessarily have to be country-specific. Therefore “pre-payments”, especially where transactions include bills of exchange, should be handled with due care and circumspection.
12.Dec.2012




[i] Published in Trade & Finance, (under The State Administration of Foreign Exchange), March 2013, China.
[iv] Import of Goods and Services, RBI/2012-13/13 Reserve Bank of India Master Circular No.13 /2012-13 dated July 02, 2012.

No comments:

Post a comment