Article

by King-Tak Fung

Article 39 of UCP 600 on assignment of proceeds retains exactly the same wording as Article 49 of UCP 500. In substance, the UCP provides that a beneficiary would be entitled, to the extent it is permissible under the applicable law, to assign the L/C proceeds even if the L/C is not transferable. However, UCP 600 remains silent with regard to the differences between a "transfer" and an "assignment", a subject which may be of interest to bankers and L/C practitioners.

This article will analyze the issues from the perspective of Hong Kong and English law, and the last section will address the relevant issues as they relate to the latest law in the People's Republic of China (PRC).

"Transfer" v. "assignment"

An assignment of L/C proceeds is an assignment (or transfer) of future debt payable under an L/C from the beneficiary to another person, i.e., the assignee. It enables the assignee instead of the beneficiary to receive payment under the L/C. Note that an assignment of proceeds does not convey a right to draw or to perform under the L/C. In other words, the drawing must be made by the named beneficiary, although the right to receive the proceeds is vested in the assignee.

By contrast, when an L/C is "transferred" to the transferee, the right to draw or to perform under the L/C is also transferred to the transferee. The transfer of an L/C provides for a second beneficiary, i.e., the transferee, to present documents pursuant to the L/C and so be paid.

Based on the above analysis, the role of an assignee under an assignment is relatively passive because, insofar as L/C payment is concerned, an assignee can only wait until the L/C proceeds emerge, but a transferee can take an active role to draw on the L/C.

Ways of effecting assignment

Since how an L/C may be transferred is neatly set out in UCP 600, this article focuses on the legal aspects of the assignment of L/C proceeds.

There are two common ways to assign L/C proceeds: namely assignment by way of purchase and assignment by way of security.

Assignment by way of purchase takes the form of a true sale and purchase transaction between the L/C beneficiary and the assignee. In effect, the assignee is purchasing the debt (i.e., receivables under the L/C) from the L/C beneficiary. As a result, the L/C proceeds, after assignment, are no longer the property of the L/C beneficiary but the property of the assignee.

Note that even though the assignment of L/C proceeds is by way of purchase, it could still be structured in a way that the purchase is with recourse to the L/C beneficiary upon the occurrence of certain events, e.g., insolvency of the issuing bank.

Assignment by way of security takes the form of collateral for a loan. The assignee advances funds to the L/C beneficiary and takes the L/C proceeds as security backing such advances. Under this arrangement, the L/C proceeds remain the property of the L/C beneficiary, but are subject to the security interest of the assignee.

Types of assignment

No matter how the assignment is effected, an assignment can be classified either as a legal assignment or an equitable assignment.

A legal assignment is an assignment that satisfies all of the following three requirements:

(i) the assignment is in writing;

(ii) the assignment is absolute, meaning that it assigns all the interests under the L/C; and

(iii) a notice of assignment is served on the obligor of the L/C, e.g., the L/C issuing bank.

An assignment will become an equitable one if any one or more of the aforesaid elements is missing.

An assignee under a legal assignment will be entitled to sue the L/C obligor in its own name. However, under an equitable assignment, the assignee will have to join with the L/C beneficiary to take legal action against the L/C obligor as coplaintiff or, if the L/C beneficiary refuses to sue the L/C obligor jointly with the assignee, to sue the L/C beneficiary as co-defendant together with the L/C obligor when the L/C obligor defaults in payment. This explains why banks generally prefer to obtain a legal rather than an equitable assignment.

Common questions

Is registration required for an assignment? If an assignment is obtained by way of purchase, no registration of the assignment is required under Hong Kong and English law, since the proceeds are no longer the property of the L/C beneficiary.

However, if the assignment is obtained by way of security, the registration requirement will apply. The consequence of failing to register a registrable assignment will render the assignment void as against the liquidator and creditors of the L/C beneficiary.

Is notice of assignment required to be served on the issuing bank? If an L/C is silent on whether the L/C proceeds may be assigned by the L/C beneficiary to a third party, the presumption is that assignment of the proceeds is permissible. Under Hong Kong and English law, if there is no prohibition on the assignment of L/C proceeds, the assignee is not obliged to give a notice of assignment to the L/C obligor in order to render the assignment legally valid and enforceable. However, failure to serve a notice of assignment on the L/C obligor may lead to the following consequences:

(i) Right to sue

The assignee has no right to sue the L/C obligor in its own name, because the assignment is an equitable assignment.

(ii) Good discharge by payment to the L/C beneficiary

In the absence of a notice of assignment, the L/C obligor obtains good discharge by effecting payment to the L/C beneficiary, even if the L/C beneficiary subsequently fails to pass the L/C proceeds to the assignee.

(iii) Priority to the L/C proceeds

If the L/C beneficiary fraudulently assigns the L/C proceeds to more than one assignee, the assignee who first serves a notice of assignment on the L/C obligor will have priority to the L/C proceeds.

(iv) Set-off rights by L/C obligor

The cut off of set-off rights between the L/C obligor and L/C beneficiary rarely happens due to the L/C autonomy principle. However, in an open account sale and purchase transaction, a notice of assignment will cut off the set-off rights of the debtors against the seller. This means that from the time the notice of assignment is duly served on the debtor, the debtor will not be entitled to set-off the sales proceeds against any debt owed by the seller to the debtor. This is of critical importance in account receivables financing transactions.

Is it necessary for an acknowledgment of the notice of assignment to be obtained from the L/C obligor? Under Hong Kong and English law, unless the L/C provides otherwise, no consent from the L/C obligor is required for assignment of the L/C proceeds, and therefore no acknowledgment of the L/C obligor signifying its consent to assignment is strictly necessary for the fulfillment of the assignment.

That said, the acknowledgment of the notice of assignment does give additional benefits to the assignee, because an acknowledgment will be cogent proof that the notice of assignment has been duly served on the L/C obligor. In daily banking practice, if a notice of assignment is successfully sent by way of an authenticated SWIFT message, an "ACK" code signifying that the notice has been duly served on the L/C obligor will be automatically generated. In such circumstances, a separate acknowledgment from the L/C obligor is not necessary.

Assignment under PRC law

Assignment by way of purchase

According to Articles 79 and 80 of the Contract Law of the PRC, the rights under an L/C may be assigned to a third party if there is no prohibition on assignment in the L/C. However, a notice of assignment must be served on the L/C obligor, failing which the assignment will not be valid or enforceable under PRC law.

Assignment by way of security

In the past, it was not certain in the PRC whether L/C proceeds could be assigned to a third party by way of security. With the new Property Law, effective as of 1 October 2007, it is now clear that receivables (including L/C proceeds) are assignable to a third party by way of security. The relevant provision is Article 223 of the Property Law.

Registration requirement

As per Article 228 of the Property Law, if the L/C proceeds are assigned to a third party by way of security, registration with the relevant PRC authority (i.e., The Credit Information Centre of The People's Bank of China, the Central Bank) is necessary in order to render the assignment legally valid and enforceable.

Conclusion

To sum up, an assignee of L/C proceeds takes a passive role in receiving the monies under the L/C, whilst a second beneficiary under the L/C takes an active role in drawing on the L/C.

With respect to the assignment of L/C proceeds, assignment can be effected by way of purchase or by way of security, and if assignment is by way of security, registration would be required under Hong Kong and English law to ensure the priority of the assignment.

Under the PRC Law, assignment of L/C proceeds can also be done by way of purchase or by way of security. However, if assignment of the proceeds is by way of security, registration would be required to ensure the validity and enforceability of the assignment under the new PRC Property Law.

King-Tak Fung is a banking partner of DLA Piper specializing in international trade law and practice, a member of the ICC Consulting Group on the UCP 500 revision and author of Leading Court Cases on Letters of Credit published by ICC Publishing.
His e-mail is kingtak.fung@dlapiper.com