Tuesday, November 27, 2018

Negotiation: The Concept

The problem with ‘negotiation’
In trade finance and documentary credit operations, the word ‘negotiation’ remains one of the most enduring enigmas of all times. No one describes the situation better, perhaps, than Ole Malmqvist, a member of the UCP Drafting Group for UCP 600 and one the most revered experts in the business. He said:
.... 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 ....The word ‘negotiation’ is a problem.... I think we should get rid of the word ‘negotiation’ because we cannot define it and because we don't need the concept…. [1]
“…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![2]”.
Reinhard Längerich says,[3] “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.”
The fact remains that in spite of such sever criticisms, ‘negotiation’ is alive and well – reigning in full glory since its inception, including in the latest version of the UCP. Since we must continue to live with it, this article is yet another attempt to explain the concept, to provide yet another answer (the fourth, according to Ole Malmqvist!).
Article 2 of UCP 600 defines the term ‘negotiation’ 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.”
This definition appears flawed for the following reasons[4]:
(1)   “Negotiation means the purchase….of drafts (drawn on a bank other than the nominated bank)…and/or documents …etc.”: The terms ‘negotiation’ and ‘purchase’ are not interchangeable, for reasons explained later.
(2)   “Negotiation means the purchase….of…by advancing or agreeing to advance…”: An ‘agreement to advance funds’ is not the same as an advance or loan (any liability, for that matter) outstanding in the books of a bank against a borrower. There is no certainty that an agreement will be converted to a loan in the future. An ‘agreement to advance funds’ creates no obligation or liability against the borrower, carries no risk exposure for the lender, does not affect the balance sheets of either the lender or the borrower; issue of recourse or non-recourse payment does not arise.
(3)   “…on or before the banking day on which reimbursement is due to the nominated bank”:
The words ‘on or’ should be deleted. Where the value date of reimbursement and the so-called ‘advance’ is the same, no liability or advance would be outstanding in a bank’s books. The bank takes no credit decision, does not pay from its own funds, is not out of pocket, and creates no non-fund liability. There is no ‘purchase’ or ‘negotiation’, no risk exposure whatsoever and hence, no advance.
More confusion about ‘negotiation’
Let us examine the following scenarios:
(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)      “Receipt or examination and forwarding of documents by a nominated bank that is not a confirming bank does not …. constitute honour or negotiation.” (UCP 600, sub-article 12.c)
(c)      “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).”[5]
It is strange logic that mere promise or revocable agreement to provide value (definition or extent of exposure still indeterminate) on any future (but indeterminate) date is conferred the definition of ‘negotiation’. In contrast, sending the very same documents ‘on approval basis’, or for acceptance by the issuing bank (well before fund is provided to the beneficiary), is not.
The laws of contract
What then is negotiation; how should it be defined? To explain the concept it was necessary to find a point of reference, something like a peg to hang it from. Section 2 (Interpretation Clause) and a few other clauses of the Indian Contract Act, 1872 (modelled on the English Contract Laws) provided a convenient platform for this exercise. Loosely translated, its selected sub-clauses under Clause 2 are as follows:
(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 (or an offer).
(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.
(c)      Every promise and every set of promises, forming the consideration for each other, is an agreement.
(d)      An agreement not enforceable by law is said to be void. An agreement enforceable by law is a contract.
(e)      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.
Clauses 7 and 8 of the Act state that:
7.      “In order to convert a proposal into a promise, the acceptance must -
(a)      be absolute and unqualified;
(b)   be expressed in some usual and reasonable manner, unless the proposal prescribes the manner in which it is to be accepted. 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.
8.      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.”
Negotiation and the laws of contract
On placing a letter of credit next to the above, we observe the following:
1.      A letter of credit is an explicit proposal, specifically addressed to a person (the beneficiary) named in the credit.
2.      The proposal (in the form of a letter of credit) specifies the ‘manner in which it is to be accepted’.
3.      A complying presentation to a nominated bank constitutes 'performance of conditions of the proposal’ (the LC) ‘in the manner prescribed’; it signifies ‘an acceptance of the proposal’. The acceptance (performance) entitles the beneficiary and the negotiating bank (as agent) to receive consideration under the contract.
4.      Where the presented is discrepant, obviously ‘the acceptance is not made in such manner’ as prescribed by the proposer (sub-clause 7.b). It is ‘a reciprocal promise…offered with a proposal’. The acceptance is not ‘absolute and unqualified’. We may call it a conditional acceptance, a fresh proposal or counter-offer.
Continuing with sub-clause 7.b, if the acceptance is not ‘unqualified’ (the presentation being discrepant), the proposer – i.e. the issuing bank – within a reasonable time after ascertaining the discrepancies, is within its rights to insist that its proposal be accepted only in the prescribed manner (in compliance with the credit terms); else, refuse the documents (sub-article 14.b and Article 16 of UCP 600).
However, if the issuing bank (the proposer) fails to convey refusal along with the reasons for doing so, it must (or, is deemed to) accept the ‘reciprocal promise’, conditional acceptance or counter-offer (refer to sub-article 16.f of UCP 600).
5.      By confirming a credit, a confirming bank steps into the shoes of the issuing bank. For this reason, payment by a confirming bank is without recourse.
Negotiation: the concept
Negotiation essentially denotes a process within this framework. The focal point of this process is compliance – ‘absolute and unqualified’ acceptance of the issuing bank’s proposal (a complying presentation). A negotiating bank is an essential link in this chain, being nominated by the proposer/offerer (the issuing bank) in terms of UCP 600, Article 6, as a necessary condition for the performance of the beneficiary and ‘the manner in which it [the LC terms] is to be accepted’. If a presentation (i.e., the act of acceptance by the beneficiary) is at variance, the presentation does not comply; sub-clause 7(b) kicks in. The spirit of this clause is reflected in Article 16 of UCP 600.
Purchase, Collection
In collection transactions, the difference lies in the fact that the subsisting promise or offer, call for 'acceptance' or 'performance' on the lines as described in the laws of contract – are between the buyer and the seller. There is no issuing or negotiating bank. The intermediary banks are not required to verify compliance. If a bank decides to purchase the documents submitted, it is a financing decision – purely between the lending bank and the borrower.
Negotiation, financing and the UCP
Thus, negotiation has everything to do with performance or compliance under documentary credits; it has nothing to do with financing. Unfortunately, in its attempt to straddle two dissimilar functions, in trying to be everything to everybody, the term negotiation may have caused more confusion, debate, court cases, argument and frustration than could have ever been contemplated. The analysis shows why the UCP should be de-linked from all forms of financing (including advancing or agreeing to advance funds), terms of payment, pre-payment, payment with or without recourse. The following revised definition is suggested as a way forward:
“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 its declaration on its covering schedule that it has negotiated against a particular documentary credit of the issuing bank.”

[1] DCInsight Vol. 10 No.4 Oct - Dec 2004.
[2] DCInsight Vol. 12 No.2 April - June 2006
[3] DCInsight Vol. 10 No.2 April - June 2004
[4] For a detailed comment on ‘negotiation’ by this writer, refer to article ‘Re-defining Negotiation’, LC Monitor – Trade Services Update, Volume 11, Issue 4, July–August 2009.
[5] ‘Suggested answer’ to question no. 2.15, Frequently Asked Questions on UCP 600, Gary Colleyer.

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