INTERNATIONAL
CHAMBER OF COMMERCE, PARIS
When
a non-bank issues a letter of credit
Department
of Policy and Business Practices
ICC Commission
on Banking Technique and Practice,
Because
of widespread interest in this subject, the ICC Banking Commission has decided
to post its official Opinion on non-banks and letters of credit on the ICC web
site. The Opinion follows.
Articles 1 and 2 of UCP 500
When
a non-bank issues a letter of credit
Query
We
have been receiving a significant number of enquiries about letters of credit
which are advised by some banks in the usual way, but are actually issued by a
corporate, or the finance arm of the corporate and not a Bank.
These
predominantly corporate L/Cs from Country U are ‘advised’ by banks on their
letterhead in a SWIFT MT 700 format, and to all intents and purposes appear to
be bank issued L/Cs, with the requirement to present documents to the advising
or transferring bank, where documents will be processed and payment made after
receipt of funds from the ‘issuer’.
Invariably
they incorporate clauses to the effect that the L/C is subject to the UCP, and
that where the UCP refers to ‘issuing bank’ then the issuer is to be construed
as acting in all respects as the ‘issuing bank’.
Notwithstanding
the fact that legally any entity can issue a letter of credit, our
understanding is that the UCP only contemplates as issuers banks, on the basis
that the issuing bank is undertaking a third party, independent guarantee of
payment to the seller (beneficiary). It is this independence of a banker's
letter of credit that is key to the payment undertaking.
The
requirement by the seller for a letter of credit is two-fold: first that he has
a guarantee of payment, and second that he can use the credit to raise
pre-shipment finance from his banker.
In
the case of the corporate L/C as we understand it, the guarantee of payment is
not normally by an independent third party, and, as such, the credit risk is
that of the corporate entity issuing the credit. Similarly when documents are
presented under the L/C for negotiation, that negotiation if any, is based on
the risk of the issuing entity, i.e. is corporate, not bank risk.
We
would be grateful if the ICC Commission on Banking Technique and Practice would
advise on the following:
1.
Is it acceptable practice for a bank to advise a
corporate letter of credit in the same way as a bank-issued letter of credit
without drawing attention to the ‘non-bank’ nature of the issuing entity? Does
the Commission consider appropriate guidelines should be published? If so what
will these say?
2.
What is the position if the corporate issuer were
to apply for liquidation, bankruptcy, or protection from creditors (e.g. file
for Chapter 11), and how different is the position to that of when a bank is
unable to meet its obligations.
Analysis
The
UCP reflects that state of practice, namely a situation where the issuer or
other actor on a letter of credit is a bank. As a result, although there is no
affirmative rule in the UCP prohibiting entities that are not banks from
issuing, confirming, paying, negotiating, or advising letters of credit, its
vocabulary (‘issuing bank’, ‘confirming bank’, etc.) assumes that these
entities are banks.
This
assumption is based on the recognition that there are three principal
advantages to bank issuance and handling of letters: namely that banks have the
operational expertise to handle issuance and presentation under letters of
credit in a professional manner, that they have the tradition of independence
from the underlying transaction which is the basis of the commercial reputation
of the letter of credit, and that in virtually all countries banks are
specially regulated with a view toward protecting those who rely on their
undertakings.
These
matters are of considerable importance to the integrity of the letter of credit
as an instrument of commerce and to its dependability as an instrument of
payment.
However,
neither the Commission on Banking Technique and Practice nor the UCP can
determine who is empowered to issue letters of credit under local law nor who
may issue its undertakings subject to the UCP. That restriction on the issuance
of letters of credit is a regulatory matter under local law should be obvious.
In some countries, non-banks can issue letters of credit, although there may be
limitations where they are used in consumer situations. In other countries,
issuance is limited to financial institutions, but it is less clear that only
banks constitute financial institutions. As a result, non-banks that are
financial institutions, such as insurance companies, can issue letters of
credit in some countries.
It
may be less apparent that the UCP cannot itself limit the scope of its
application. The UCP is a set of voluntary rules of practice. The rules can be
modified or excluded by the undertaking that is issued subject to them as is
recognized in UCP 500 article 1 (Application of UCP) (The provisions ‘are
binding on all parties thereto, unless otherwise expressly stipulated in the
credit.’). Issuance by a non-bank constitutes such a modification. Even if the
UCP expressly prohibited issuance by a non-bank, this prohibition could be
modified because the UCP is not a legislative act that can restrict the manner
in which it can be applied.
Where
a letter of credit is issued by a non-bank, the non-bank issuer should be held
to the same obligation and standard of care as would a bank. In either case,
the obligation is to pay against the presentation of documents that comply with
the terms and conditions of the credit and that determination is to be made
based solely on the documentary presentation and not on the status of
reimbursement obligations or the underlying transaction, and local law should
apply the same principles to an independent undertaking regardless of who makes
it.
Having
concluded that a credit can be issued subject to the UCP by a non-bank,
however, does not mean that it is prudent for a beneficiary to accept such a
credit. Issuance through an advising bank does mitigate the issue of whether
the credit is authentic and presentation of documents to a bank does reduce
some operational risks. There is, nonetheless, the risk of the creditworthiness
of the issuer and country risk. These risks apply equally whether the issuer is
or is not a bank and a beneficiary should always assess whether it is prepared
to accept the credit and country risk associated with the issuer. If not, it
should require confirmation by an entity with which it is comfortable.
There
remains, however, an additional risk that may not be apparent to beneficiaries,
namely the risk of neutrality of the issuer. This risk is somewhat more
intangible but is very important. It is the risk that, when presented with
documents, the issuer may be influenced by factors other than whether they comply
on their face with the terms and conditions of the credit and may exercise
certain discretionary judgments in examining documents against the beneficiary
where it would not otherwise do so if external factors were different. While
this risk is not confined to non-banks, the reputation of individual banks for
integrity is well known in the letter of credit community and one which most
banks that regularly engage in letter of credit practice work hard to maintain.
It is less apparent that when faced with a poor credit decision, an insurance
company will approach the problem in the same way as would a letter of credit
banker rather than as an insurer, which may be inclined to reject all arguable
claims and engage in litigation to settle any colourable dispute.
Similar
concerns would apply to corporate issuers on behalf of themselves or affiliated
companies, even though two-party letters of credit are recognized by UCP 500
article 2 (Meaning of credit) (‘and on the instructions of a customer (the
'Applicant') or on its own behalf’).
For
these reasons, it is in the interest of banks generally to inform corporate
letter of credit users of the advantages of having a bank's obligation, either
as the issuer of a credit or as the confirmer of a credit issued by a non-bank.
There would be no objection under standard international letter of credit
practice to informing specifically the beneficiary of such a credit as to the
nature of the issuer in addition to emphasizing that the advising bank assumes
no liability, although in the absence of agreed standards such a decision
should rest with the individual bank involved.
Of
course, where the manner of issuance misleads the beneficiary into believing
that the issuer is a bank, the advising bank may expose itself to liability.
Ultimately, however, the decision as to whether or not to accept the risks
associated with a non-bank issuance rests with the beneficiary.
Conclusion
- It does not ‘violate’
the UCP for a non-bank to issue a credit subject to the UCP even though
such issuance is not contemplated in the rules. The UCP does not
specifically provide for bank advice of non-bank issued letters of credit.
Such an advice should accurately identify the issuer and indicate the
advising bank's limited role. If the form of advice refers to the ‘issuer’
as ‘issuing bank’ or otherwise gives the impression that it is a bank, it
is recommended that the advice affirmatively disclose the non-bank status
of the issuer in order to correct any mistaken impression caused by such
reference.
- The consequences of
insolvency are a matter for local law, whether the insolvency is that of a
bank or non-bank issuer. In either case, however, the beneficiary assumes
the risk of the creditworthiness of the issuer unless it is offset by
obtaining confirmation or credit insurance.
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