Article

by Boris Kozolchyk

UCP 600 introduces a number of improvements, but it also highlights the difficulties of trying to lay down allencompassing definitions and provisions for every detailed situation in a set of basic rules. In my view, future UCP revisions should aim at a more closely defined target - that of listing the essential axiomatic principles applicable to letter of credit operations. A UCP of this type would not have to be modified every time there was a change in market practice. More detailed rules and guidance - currently to be found in a variety of ICC publications - could then be brought together in the ISBP as an integrated compilation of practices that could more readily be revised whenever needed.

Within the above context, this article first examines the nature of the UCP, the principles that inspired the UCP 600 drafting process and some of the detailed provisions in UCP 600 that may cause problems in practice. The article concludes by examining how the revision procedures might be made more effective in the future.

What is the UCP?

The UCP is an authoritative compilation of the customs and practices of commercial letters of credit observed by most of the participants in the transaction and promulgated by an organization that represents the various trades and professions involved with this instrument. No less important, the UCP contains principles that inspire its observance. These principles came about only after it became clear to drafters of earlier versions of the UCP that some of the customs and practices deserved preservation and lasting influence. It is the force of principles such as the documentary nature of the issuing or confirming bank's obligation to the beneficiary, its independence from the underlying transaction(s) and the strict and facial method of determining compliance that have made the UCP not only the "living law" among the users of commercial letters of credit, but also part of the "official" or "positive" law of commercial letters of credit of many jurisdictions.

UCP 600 and 500 principles

I have found some of the new formulations of customs and practices in UCP 600 to my liking. For example, subarticle 14(b) will hopefully eliminate the endless misinterpretations of its UCP 500 predecessor by fixing the time of preclusion at five banking days after the day of presentation. Similarly, I like article 17's clarification of the meaning of "original" and "copies". Nevertheless, the question remains whether the drafters of UCP 600 intended a change of direction from that taken by UCP 500 as well as earlier versions.

According to Gary Collyer, the able Chair of the Drafting Group of UCP 600, the spirit of the revision was to implement goals such as:

- to encourage banks and their applicants to be more explicit in the terms of their credits;

- to take account of the removal, merging or modification of articles that give rise to risk of ambiguity or misinterpretation; and

- above all, to look at the presentation, the parties involved and the goods before refusing documents for reasons that have no real bearing on the underlying transaction, the credit or the rules in UCP 6001 (emphasis added).

With the exception of the last goal, which I find puzzling and to which I will return later, the other goals do not appear to attempt a change of direction. The first has been a guiding principle ever since the 1962 revision when Bernard Wheble introduced it as part of what he referred to as the "London Practice" 2, and the second is a warning about the removal or modification of UCP 500 language. Nonetheless, a significant departure from pre-existing principles may have taken place.

UCP 500 had retained the principles that inspired UCP rules for at least half a century, such as the independence of the letter of credit promise, a facial examination of documents, neutrality between applicant and beneficiary and finality of payment by the issuing and confirming banks. In addition, UCP 500 adopted its own principles3. These are: (i) fidelity to existing documentary practices4, and in case of conflict between practices, a choice based upon cost effectiveness and fairness to all participants5; (ii) standard banking practice as the primary source for the determination of strict and facial compliance, thereby encouraging court decisions to respect this practice6; (iii) strengthening the integrity and reliability of the credit promise and of the key documents, especially those that convey title to the shipped or stored goods7 and (iv) facilitation of incipient practices, especially for standbys and electronic credits and documents. Because of space limitations, I will limit my analysis to only some of the changes that could have a major impact on pre-existing principles.

The UCP 600 definitions

The introduction of a number of all-encompassing definitions in UCP 600 is likely to entail departures from UCP 500 principles. By all-encompassing, I mean definitions applicable throughout the entire text and not merely to some of its sections. A proposal to create a list of definitions was rejected by the drafters of UCP 500. At that time, revised Article 5 of the Uniform Commercial Code (UCC) of the United States was being drafted, and those of us who participated in both drafting efforts relayed to our fellow drafters of UCP 500 the unsatisfactory experience of attempting to extract definitions from very fluid or constantly changing practices8.

Thus, the UCP 500 rejection of a definitional section was motivated by the freezing effect that all-encompassing definitions have upon evolving practices9. Worse still, defined practices also tend to freeze the meaning of related practices. And in contrast with a legislative context where mistakes can be corrected by the application of customary law as a complementary source, mistakes in customary law definitions cannot rely on non-commercial or banking legislators or judges to cure them10. Attempts to cure mistaken definitions by subsequent clarifying Opinions or Position Papers only detract from the credibility of the effort. With this in mind, let me turn to some definitions.

Honour

"Article 2. Honour means:

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." (emphasis added)

This definition presupposes that a payment must take place for honour to occur in any of the three listed instances. But "honour", legally as well as in banking parlance, means simply to fulfil one's promise. Thus, if a bank promises, say, first to accept and then to pay, having accepted it has honoured its obligation to accept. This is the reason why a legal procedure known as a "protest" in some jurisdictions and a "notice of dishonour" in others is used to establish liability for dishonour, either for lack of acceptance or of payment.

Negotiation

A subsequent definition of "negotiation" in the same article is supposed to complement that of honour. Surprisingly, it restricts negotiation to the purchase of drafts drawn on a bank other than the nominated bank11. The term "nominated" bank, in turn, is defined as "the bank with which the credit is available or any bank in the case of a credit available with any bank".12 Accordingly, an issuing bank that nominates itself to negotiate a draft drawn on it cannot "negotiate" it because the draft is not drawn on another bank. Aside from unexplained exclusion of advising banks that only advise from the category of nominated banks13, the meaning of nomination is made dependent upon the undefined notion of availability. Availability seems to have two meanings in UCP 600: type of liability assumed by the obligated bank (as in acceptance, negotiation and payment) and geographic location of the assumed liability, regardless of its type14.

Finally, an issuing bank's honour where it promises to negotiate is defined under article 7 as a subsidiary type of liability; once a nominated bank does not negotiate, then the issuing bank is obligated to do so. This rule may have an explanation in the above definition of negotiation that prevents a negotiating bank from negotiating a draft drawn on it. The net result of this labyrinthine tour among expressed and implied definitions is to exclude two common instances of honour: 1) a deferred payment undertaking paid by the issuer prior to its maturity, and 2) a negotiation by an issuing bank of a draft drawn on and accepted by it.

If the UCP does not deem as honoured a prepaid deferred payment credit (probably with a discounted amount), a payor bank that does not obtain a release of liability from the beneficiary, in principle, continues to be liable for the difference between the discounted and the full amount of the credit. The beneficiary who receives such a payment, in turn, continues to be exposed to a recovery of the discounted amount as a non-final disbursement in the numerous jurisdictions that lack a finality of payment rule such as found in UCC Article 515. An allegation of beneficiary fraud or of mistaken payment by the payor bank may suffice to attach funds paid during the interval between the date of discounted payment and the maturity date16. Yet, UCP 600 itself leads to the conclusion that its article 2 exclusion of honour by prepayment does not make sense. For if a nominated bank can prepay and thus honour (per sub-article 12(b)), a fortiori, why should the issuing bank not be able to do so?17

The integrity and finality of a negotiation by an issuing bank is similarly undermined where this negotiation is not deemed an instance of honour, even where such a negotiation is, as is usually the case, without recourse on the beneficiary. Suppose that the credit is payable at a time subsequent to the presentation of the draft, and it stipulates that the draft is negotiable "at its counters at the prevailing libor rate" (as it appeared in several credits recently examined by this writer). Why should the beneficiary of such a promise to negotiate not be able to rely on it? Unlike what my friend Donald Smith believes,18 an issuing bank may negotiate such an accepted time draft, even if (and often precisely because) it is its acceptor. If the amount paid on that draft is acceptable to the beneficiary in full payment of the credit - he signs a release of liability and the issuing bank waives recourse against the beneficiary - why should this payment not be another instance of final payment and honour as is the case with a similar negotiation effected by a confirming bank per sub-article 8(a) of UCP 600? Conversely, why should the issuing bank-payor of such an acceptance not be able to rely on it as an instance of honour and no longer have to carry in its books the difference between the discounted amount and the face amount of the credit as a firm liability? An ICC-sanctioned source of standby letter of credit law expressly contradicts the UCP 600 exclusion. In the words of ISP98 §2.01(iii), honour can occur: "by negotiation, in which case the issuer pays the amount paid at sight without recourse".

Moreover, as this definition of honour is superimposed upon the asserted undertaking by the issuing bank in sub-article 7(a)(v) (an obligation to negotiate only if the nominated bank does not negotiate), a troubling doubt emerges as to the scope of the issuer's undertaking. Is an issuer of a negotiation credit containing a promise to negotiate (such as quoted earlier) obligated under UCP 600 to negotiate such a credit from the moment of its issuance as would appear from sub-article 7(b) (which imposes an obligation to honour as of the moment of issuance), or is it only obligated to negotiate if the nominated bank (virtually any bank if the credit is one of free negotiation) per sub-article 7(a)(v) does not do so? And if so, how can the failure to negotiate a freely negotiable credit be established?

If honour by the issuing bank does not encompass negotiation of its own negotiation credit, the issuer's undertaking may well be only subsidiary to that of another nominated bank. It is true that a negotiator may refuse to negotiate if the beneficiary does not accept the proposed (and presumably reasonable LIBOR or market-based) discount rate. Yet, such a rejection would be based upon a rule other than that which states that a beneficiary cannot approach an issuing bank for its negotiation until a nominated negotiating bank has been unsuccessfully approached.

As with the exclusion of prepayment in connection with deferred payment credits, the unwillingness to ascribe honour and finality to a negotiation without recourse by the issuing bank exposes both the negotiating bank and the beneficiary to the consequences of lack of finality set forth earlier for deferred payment credits.

The abrogation of UCP 500 article 30

UCP 500 contained a provision (article 30) that limited the circumstances in which banks would accept transport documents issued by freight forwarders. In my article "The Unwarranted Comeback of the FIATA Bill of Lading" (DCInsight, April-June, 2005), I expressed concern that article 30 of UCP 500 was in danger of being abrogated following a series of ill-conceived Banking Commission Opinions. These Opinions led to the conclusion that a credit that required an ocean bill of lading could be complied with by bills of lading issued by freight forwarders as carriers or multi-modal operators. My article distinguished between these transport documents and explained why, say, a liner ocean bill of lading conferred much stronger rights on a beneficiary, applicant, issuing, confirming or negotiating bank which relied on such a transport document (and some of the above as collateral) than the rights conferred by a freight forwarder-issued document. This is a distinction that mutatis mutandis also applies to an ocean bill of lading signed by a charterer of a vessel as contrasted to one signed by the ship's owner, notwithstanding UCP 600 sub-articles 14(l) and 22(a)(i).

In that article, I pointed out that this is a moment when the banking industry needs to restore the letter of credit to its status as a fully fledged payment and credit instrument. I suggested that accordingly it does not make sense to undermine the integrity of the ocean bill of lading as a valuable and liquid document of title, especially as this status is re-emerging with an electronic format in futures markets and the secured lending laws of - in particular - developing nations19. My concerns on this issue have not been resolved by UCP 600, which, moreover, contains no provision equivalent to article 30 of UCP 500.

Changing the UCP drafting method

All-encompassing definitions of customary law institutions depend upon pre-existing clearly articulated and universally accepted principles. Take for example, the principle "In credit operations all parties concerned deal with documents, and not with goods, services ...". As noted earlier, such a principle emerged from the selection of best practices and has attained the status of an axiom, i.e., a documentary credit cannot pretend to be such unless it is documentary and does not deal with goods.

Axioms are not democratic beings. It would be as senseless to decide if documentary credits can deal in goods by voting on it as it would be to vote on whether two plus two amounts to four. Thus, unless the question before the banking associations were "Should we abandon documentary credits as instruments of payment and finance as too costly or inefficient?" (a legitimate voting issue), those principles that have proven to be axioms of letter of credit law and practice should be left undisturbed by the democratic process.

The preceding discussion illustrates how some of the axiomatic principles of letter of credit law and practice as embodied in UCP 500 are in jeopardy. A similar effect may be looming large with the announced de-emphasis of the facial standard for the examination of the documents and by the need to take into account whether the presentation's discrepancies have a "bearing on the underlying transaction" alluded to in Gary Collyer's third main goal of the revision.

I would like to propose a different course for future revisions. UCP 500 sub-article 13(a) empowered international standard banking practice to be the normative source for the determination of compliance. Accordingly, ICC promulgated the ISBP, and UCP 600's articles 2, and sub-article 14(d) re-affirmed this function. The time has come to crown the UCP and limit its scope to the listing of its axiomatic principles, much as was done by ISP98 with its "general principles"20. This skeletal, but long-lasting UCP would also set forth the principles that guide standby and electronic letters of credit. Meanwhile, the ISBP should become the permanent repository of periodic and wholly democratic revisions of customs and practices. These revisions would incorporate, not only new customs and practices, but also widely accepted Banking Commission Opinions and DOCDEX Decisions, ISP98 and bank-to-bank reimbursement rules in a harmonized way, rather than in the present, often conflicting, fashion. The newly approved standard practices would have to be consistent with the "crowned" UCP principles. The aim of this proposal would be to facilitate the work of the document checker, who is presently saddled with having to check not only the letter of credit, the documents, the UCP, the ISBP but also perhaps the eUCP, the ISP98 and ICC Publication 525. It would also make the living law of letters of credit more predictable by ensuring its consistency with its underlying principles.

Boris Kozolchyk is the Evo de Concini Professor of Law at the University of Arizona, James E. Rogers College of Law in the US and the President and Director of the National Law Center for Inter American Free Trade. His email is b.kozolchyk@natlaw.com

1. See Gary Collyer, "A look back at the UCP revision", DCInsight, vol 12 no. 4, October-December 2006, p. 22.

2. See Bernard Wheble, "Documentary Credits - Uniform Customs and Practices", J. Inst. Bankers 27 (London, Feb.1963).

3. See this writer's Memorandum to the ICC Banking Commission outlining these principles in ICC Doc. No. 470-34, Section I, Working Party Report UCP Revision, Articles 1-24, 54-55, 1991.O5.27; see also B.Kozolchyk, "Towards New Customs and Practices for Documentary Credits: The Methodology of the Proposed Revision", Commercial Law Annual 1993, 37.

4. Sub-article 13(a) ascribes a banking practice meaning to the judicially inspired "strict" standard and also displaces the judicially or doctrinally inspired "substantial" and "bifurcated" standards; on amendments it prevents the "shell game" practice that kept the beneficiary guessing on the wording in force (sub-article 9(d)(ii)). It establishes uniform elements for each of the transport documents (articles 23-33); chooses a costeffective and fair meaning for negotiation (sub-article 10(b)(2)) by selecting the practice of "giving value", as opposed to not giving value and yet charging a negotiation commission, and unifies the transfer practice around a sole transferring bank (article 48).

5. Ibidem.

6. Sub-article 13(a).

7. This was accomplished by, among other rules, subarticle 6(c)'s adoption of the presumption of irrevocability; article 7's establishment of the advising bank's liability for the verification of the authenticity of the advice; sub-article 11(c)'s giving binding effect to a preliminary advice; article 9's placing primary and unavoidable liability for payment, deferred payment, acceptance and negotiation upon the issuing and confirming banks and sub-article 13(c)'s excluding non-documentary conditions from the examination process

8. After almost half a year of discussions, the final product still contained questionable definitions such as, for a "nominated person" in Section 5-102 (11) which, by requiring that such a person "pay, accept, negotiate or otherwise give value ...", excludes the advising bank that solely advises. Apparently, this definition influenced the UCP 600 definition of a "nominated bank", as it is based on "availability", and availability is based on liability for honour.

9. Consider, for example, the meaning of an "ocean bill of lading" during the two decades immediately preceding and following the First World War. Preceding the war and because of the availability of shipping space, an ocean bill of lading was synonymous with an "on board" bill. Following that war and because of scarcity of shipping space, it was only synonymous with "received for shipment". Once the scarcity disappeared, "on board" bills again became synonymous with ocean bills. The same can be said for the constantly changing meaning of "clean" bills of lading.

10. See, for example Dixon, Irmaos & Cia. v. Chase National Bank of the City of New York, 144 F.2d 759, 761-62 (2d Cir. 1944) on the still uncertain import of letters of indemnity in as important a jurisdiction as New York. For a more recent attempt to clarify a customary law definition of "original" documents, see generally, James E. Byrne, "The Original Documents Controversy, From Glencore to the ICC Decision" (Institute for International Banking Law and Practice,1999).

11. Article 2, "negotiation".

12. Article 2, "nominated bank".

13. See supra n. 8.

14. "Availability" as a type of liability assumed is found, among others, in the article 2 definitions a, b and c under "Honour" and definition of "Nominated bank", and in sub-article 7A. Availability, as related to the geographic location of the liability assumed regardless of the type of liability, is found in sub-article 6(a)(ii).

15. See Revised UCC Section 5-108(4).

16. I am referring to the specter of cases such as, in England, Banco Santander SA v. Paribas (High Court, Queen's Bench Div.Com. Court, 9 June 1999, in France, Chambre Commerciale, Cour de Cassation April 7, 1987 confirming a decision of the Paris Appeal Court (Case Report Dalloz/Sirey 1987) and Cour de Cassation, Chambre Commerciale le 23 octobre 1990, Crédit du Nord /Sté Sc ... Meubles, and in Switzerland see Emirates Bank International v. Crédit Lyonnais (Suisse) S.A. Federal Court Ruling of June 1, 2004 and comment thereto in Chang-Soon Thomas Song, "A Review of the recent Swiss Supreme Court decision on deferred payment credit from a comparative commercial law perspective", 52 pp. unpublished article on file with the author. Contrast these decisions with the decision by the Supreme Court of Korea in Industrial Bank of Korea v. BNP Paribas, 24 January 2003, Korean Supreme Court 2001 DA 68266, whose text was reproduced in 2004 Annual Survey of Letter of Credit Law & Practice, edited by James E. Byrne and Christopher Byrnes, Institute of International Banking Law & Practice, Inc. p.372.

17. Sub-article 12(b) of UCP 600 states: "By nominating a bank to accept a draft or incur a deferred payment undertaking, an issuing bank authorizes that nominated bank to prepay or purchase a draft accepted or a deferred payment undertaking incurred by that nominated bank."

18. D. Smith, "Negotiation is not always what bankers think it is", DCInsight, vol. 12 n.3, July-September 2006 p. 9.

19. See, for example, Articles 31-33 of the Guatemalan Anteproyecto de Ley de Garantias Mobiliarias, Noviembre 11 de 2006 and Articles 36-38 of the Honduran Anteproyecto de Ley de Garantias Mobiliarias, Noviembre 22 de 2006.

20. See sections 1.06 to 1.09 of the ISP98.