Article

by Jim Barnes

The UCP has long provided that "banks assume no liability or responsibility for the ... genuineness, falsification, or legal effect of any document ... the value or existence of the goods ... or for the good faith ... of the consignor ... or any other person." This general disclaimer continues in UCP 600 article 34. It is reinforced by similar disclaimers in the typical letter of credit application and reimbursement agreement. It entitles an issuing bank to recover from the applicant after paying an apparently complying presentation, notwithstanding fraud. Its effect is less certain if, before paying, the issuing bank receives notice of fraud or proof of fraud or is enjoined from paying.

The effect of the UCP's general fraud disclaimer is also less certain if the presentation is received from a nominated bank. In most cases, it does not matter whether the documents are presented for collection of the beneficiary's demand for honour or for reimbursement of the nominated bank. Either way, the issuing bank will make an independent examination of the documents and, if the documents appear to comply, will effect payment to the nominated bank within the time allowed by the UCP for honour. It makes a small difference (several days' worth of interest) if the nominated bank claims reimbursement on an accelerated basis when it has not qualified for accelerated reimbursement by itself negotiating or honouring the documents. It makes a big difference, however, if the issuing bank or a court is trying to decide whether to refuse or enjoin payment based on fraud. A collecting bank stands in the shoes of the beneficiary. A nominated bank with UCP 600 reimbursement rights stands in its own shoes.

Nominated bank reimbursement rights

UCP 600 has also long provided for reimbursement rights for nominated banks that do what they are nominated to do. UCP 600 sub-article 7(c) (and parallel language in 8(c) for confirming banks) continues this basic statement of the reimbursement rights of nominated banks and also clarifies the nature and scope of their reimbursement rights:

"An issuing bank undertakes to reimburse a nominated bank that has honoured or negotiated a complying presentation and forwarded the documents to the issuing bank. Reimbursement for the amount of a complying presentation under a credit available by acceptance or deferred payment is due at maturity, whether or not the nominated bank prepaid or purchased before maturity. An issuing bank's undertaking to reimburse a nominated bank is independent of the issuing bank's undertaking to the beneficiary."

By clarifying a nominated bank's reimbursement rights, UCP 600 effectively strengthens those rights. By declaring them to be "independent", UCP 600 provides a conceptual basis for protecting nominated banks against beneficiary fraud. L/C bankers may view this declaration of independence as unnecessary, but it will help lawyers and courts, who may recognize that L/C obligations are independent or autonomous, but not realize that reimbursement rights are independent of and supersede whatever rights a nominated bank may acquire from a beneficiary demanding honour. UCP 600 thus protects nominated banks from harm due to beneficiary fraud.

There remains the job of determining whether a particular nominated bank is entitled to reimbursement under the UCP, assuming, of course, that the issuing bank determines that the documents comply. Sometimes it is clear that a nominated bank forwarding documents is not claiming reimbursement for itself and is merely acting as a collection agent for a beneficiary demanding honour. Sometimes it is unclear if a nominated bank is claiming reimbursement and, even if it is clearly claiming reimbursement under the UCP, the validity of its reimbursement claim may be unclear.

The validity of a reimbursement claim by a bank nominated to negotiate depends on whether it "negotiated" a complying presentation. Compliance is, of course, a matter of document examination, not fraud detection. "Negotiation" was defined in UCP 500 as "giving of value". It has been re-defined somewhat in UCP 600 article 2:

"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."

As noted previously, in most cases an issuing bank is focused on documentary compliance and not on whether a nominated bank is collecting for the beneficiary or itself. If, however, a fraud issue arises, then the nominated bank may be called on to state unequivocally whether it is collecting for itself and to prove that it is entitled to reimbursement. That the nominated bank was nominated and forwarded complying documents should be apparent to the issuing bank, but whether the presentation was "negotiated" concerns facts that may be known only to the nominated bank and the beneficiary.

UCP 600 provides that a nominated negotiating bank claiming reimbursement must either advance funds or agree to do so, whether or not the issuing bank reimburses. Accordingly, a bank nominated to negotiate may validly claim reimbursement after it undertakes to advance funds to the beneficiary if the funding date is set at or before the anticipated reimbursement date. An agreement to advance funds if and when funds are received from the issuing bank is not "negotiation".

Absent confirmation, negotiation is discretionary, so the parties are free to agree on the precise terms of any negotiation. The parties may agree to vary the effect of applicable law on recourse or other rights or remedies relating to the purchase of negotiable instruments or documents. In particular, the parties may agree about who bears issuing bank credit and country risk, as well as the risk that the issuing bank wrongfully dishonours. The UCP 600 definition of "negotiation" leaves room for a range of agreements between a nominated bank and the beneficiary.

The validity of a reimbursement claim by a nominated bank other than a nominated negotiating bank depends on whether it "honoured" a complying presentation. "Honour" is defined in UCP 600 article 2 to mean "pay" or, in the case of acceptance and deferred payment credits, to accept/incur and pay at maturity. UCP 500 sub-articles 10(d) and 14(a) provided for reimbursement for nominated banks that accept/ incur without reference to payment. These UCP 500 provisions recognized the practice of parallel but independent payment by the nominated bank and reimbursement by the issuing bank on the maturity date. This practice is expected to continue under UCP 600. Accordingly, demands for proof of negotiation are expected to be made only in beneficiary fraud cases, even though this practice exposes an issuing bank to the possibility of funding an invalid reimbursement claim and later having to fund a demand for honour from an unsatisfied beneficiary.

A new middle sentence was added to the above quoted UCP 600 reimbursement undertaking to protect the reimbursement rights of nominated banks that discount their acceptances/incurred deferred payment undertakings. That new sentence and the related provision in UCP 600 sub-article 12(b) authorizing such nominated banks to discount (prepay or purchase their own obligations) were deliberately added to give weight to the act of acceptance/incurrence and to reject the notion that the reimbursement rights of nominated banks that have committed themselves to pay are subject to fraud discovered at any time before the payment due date. (I wrote about this in the April-June 2006 edition of DCInsight, "Reimbursement Rights of a 'Discounting' Nominated Bank".)

These new provisions were added despite arguments that some applicants intended deferred payment credits to be subject to a fraud defence until maturity and/or that some issuing banks might be subjected to inconsistent claims by an applicant and by a nominated bank. Most L/C bankers viewed beneficiary fraud as historically and rightfully allocable to applicants, and the inconsistent claim concern, while real, cuts both ways. The inconsistent claim concern might deter courts from interfering with L/C payments if their orders cannot effectively protect the issuing bank and any nominated bank entitled to reimbursement. Courts are reluctant to issue injunctions affecting third parties who are not before them or who can challenge their orders by suing elsewhere.

UCP 600 reimbursement in fraud litigation

The clarification in UCP 600 of reimbursement rights for nominated banks should help bank counsel persuade courts in which applicants may file injunction actions that UCP reimbursement obligations are not subject to defences based on beneficiary fraud. Of course, a fair reading of UCP 500 should yield the same result, provided the reader accepts that L/C obligations are independent and that that independence extends to reimbursement obligations as much as obligations to honour. In any case, important questions remain for courts to consider once they decide to apply UCP 600. Who must prove that a nominated bank "negotiated" or "honoured" or did not do so? What kind of evidence is sufficient to prove that a nominated bank agreed to advance funds before reimbursement is due? Does a nominated bank advance funds when it reduces (subject to recourse rights) a prior inventory loan it made to the beneficiary?

Courts will likely apply UCP 600 in ways that are familiar to them. They will no doubt use existing precedents to define what constitutes L/C fraud sufficient to deny the beneficiary protection under the independence principle. Some courts will ask whether a nominated "negotiating" bank qualifies as a holder in due course under applicable negotiable instruments law. This makes sense under a credit that engages to pay "bona fide holders", as well as the beneficiary. In any event, most nominated banks that have "advanced funds" for the beneficiary's draft will also qualify for holder in due course status.

In general, courts are likely to focus on whether interfering with payment to a nominated bank will in fact prejudice that bank rather than the beneficiary. So, these courts may want proof of prejudice to a nominated bank before denying a remedy that might have the effect of depriving a fraudulent beneficiary of funds. UCP 600 provides them with an appropriate framework for doing that job in the context of interpreting and applying the UCP provisions on reimbursement of nominated banks.

As indicated at the outset, the UCP provisions on reimbursement do not prevent an applicant from seeking injunctive relief against a nominated bank. In that context, a court can better determine the facts as to the existence, nature, and extent of a nominated bank's payment or obligation to pay and better protect the nominated bank by ordering the nominated bank not to fund (as distinguished from ordering the issuing bank not to reimburse the nominated bank). If the court determines that it is still possible to deprive a fraudulent beneficiary of funds, it may interfere with the nominated bank's obligation to fund under an acceptance, incurred deferred payment obligation, or agreement to fund under a negotiation credit. That would give the nominated bank a defence based on a court order not to fund its obligation, which is much stronger than a defence based on a court order interfering with its right of reimbursement.

Jim Barnes is senior counsel at Baker & McKenzie LLP, Chicago, Illinois. His email is James.G.Barnes@BakerNet.com