Article

Discounting the deferred payment credit

by Sheilar T. Shaffer

Among the four types of credits stipulated in UCP 600 sub-article 6 (b), the deferred payment L/C remains the most problematic. Several years ago, when the Banco Santander SA v. Banque Paribas case created a stir in the banking industry, practitioners were compelled to take a close look at this kind of credit. Some of the questions raised at that time were the following:

1 How is the deferred payment credit expressly described in the UCP?

2 What approach will a court take to this kind of L/C?

Today, concerns associated with the deferred payment credit have not ceased, even though the current UCP 600 have been implemented for two years, with sub-article 12 (b) expressly authorizing a nominated bank to prepay this kind of credit.

Case studies

Consider a common case. In an L/C arrangement with the credit stating: "available by deferred payment with Bank N". Bank N (if not the confirming bank) will consider whether or not it will assume the liability as a nominated bank when it is asked to advise such a credit to the beneficiary.

In most cases, Bank N will not initially incur the deferred payment obligation; instead it will indicate to the beneficiary that it will merely forward its documents to the issuing bank without taking any responsibility on its own. Therefore, even if it examines and forwards the beneficiary's documents to the issuing bank, Bank N, at this stage, still remains a "named nominated bank", since sub-article 12 (c) clearly provides that receipt or examination and forwarding of documents by a nominated bank (not a confirming bank) does not obligate the nominated bank to honour, nor does it constitute honour.

However, Bank N's role as a "named nominated bank" can change. In some circumstances, for example, if the documents comply with the L/C and are accepted by the issuing bank, Bank N may consider if it wishes to do something more if it receives the issuing bank's acceptance advice and the beneficiary comes to seek its proceeds based on that advice. Then what happens?

Without much hesitation, Bank N may directly advance funds to the beneficiary, for Bank N, relying on sub-article 12 (b), has obtained the issuing bank's payment undertaking which should be effectuated on the due date. But is Bank N entitled to prepay based on 12 (b)?

Sub-article 12 (b) examined

Under a deferred payment credit subject to UCP 600, a nominated bank's rights and obligations have been defined by articles 2, 6, 12, 14, 15, 16 and 35. With regard to discounting a deferred payment undertaking, sub-article 12 (b) provides: " ... 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 [emphasis added] by that nominated bank."

Compared to UCP 500, this provision takes the process a step further. On the other hand, people who turn a blind eye to the last half of the 12 (b) sentence above, namely that prepayment should be of "a deferred payment undertaking incurred by that nominated bank [emphasis added]", run a risk. By virtue of this provision, if the nominated bank is also a confirming bank, e.g., the position of Santander in the Banco Santander case, then it is entitled to discount its deferred payment undertaking anytime prior to the maturity date, because it has irrevocably incurred its deferred payment undertaking as a confirming bank. But what if the nominated bank is not a confirming bank or has not honoured the complying presentation? Is sub-article 12 (b) still applicable?

The Commentary on UCP 600 says: "This sub-article provides within the rules that any nominated bank is automatically authorized to prepay or purchase a draft accepted by it and to prepay or purchase a deferred payment undertaking incurred by it."1 This comment underlines that a nominated bank's discounting should be limited to a deferred payment undertaking incurred by it rather than by others. Furthermore, the provision, in my view, also seems to permit a nominated bank's prepayment on the condition that it should have actually incurred its own deferred payment undertaking, i.e., incurring such an undertaking triggers its right to discount.

This leads to another question: what constitutes a nominated bank's incurring its deferred payment undertaking (again assuming the nominated bank is not the confirming bank)?

ICC Banking Commission Opinion R 207 in ICC Publication No. 6322 states that the obligation of a nominated bank to honour complying documents lies in the nominated bank's willingness and its direct payment promise to the beneficiary. This position has not changed under UCP 600. Banking Commission unpublished Opinion TA 6553 elaborated on this as follows: after receiving the beneficiary's documents, a nominated bank under a deferred payment credit sent a message to the advising bank stating: "Please be informed that the documents are accepted by us for maturity date XX, at maturity date we will revert to the matter of payment of proceeds." When asked for clarification of the last sentence, the nominated bank replied: "As the credit was not confirmed by us, we are not in a position to guarantee payment at the maturity date."

The query to the Banking Commission concerned whether the nominated bank was deemed to have incurred its deferred payment undertaking within the context of sub-article 12 (b) based on the first message. The Banking Commission responded: " ... the fact that the nominated bank states that the documents are 'accepted by us' merely implies that it contends the documents represent a complying presentation. The wording used in the first message of the nominated bank does not reflect that it has incurred its deferred payment undertaking ... ."

The above opinions indicate that only an explicit and independent payment promise made by the nominated bank to the beneficiary signifies that the bank has incurred its deferred payment undertaking. Mere examination and forwarding of documents does not constitute honour, nor does advice of the documents' compliance or relaying the issuing bank's acceptance advice represent "incurring a deferred payment undertaking". Moreover, incurring such an undertaking would not automatically arise merely because of the bank's being named as a nominated bank. Therefore, if a bank, without incurring its deferred payment undertaking, nevertheless decides to discount, this would be an action irrelevant to sub-article 12 (b) - i.e., that bank would not be protected by the authority provided in sub-article 12 (b) because it had not incurred the deferred payment undertaking; it was discounting the deferred payment undertaking of another bank.

In the case above, a review of Bank N's discounting shows no indication that it ever incurred its deferred payment undertaking. Perhaps it is more reasonable to treat it as having discounted the issuing bank's deferred payment undertaking! Although such an action is not uncommon in some banking practice and has facilitated financing as well, it risks deviating from the rule found in sub-article 12 (b).

Shadow of Banco Santander

The Banco Santander case had such a strong impact that it is worth reviewing. The reason the English court treated Santander as merely an assignee rather than a confirming bank was because Santander could not claim on the issuing bank as a qualified confirming bank. The court held that Santander's rights under the UCP were irrelevant and that, even if the UCP were relevant, UCP 500 articles 2, 9, 10, 13 and 14 were insufficient under English law to protect a confirming bank that discounts its own deferred payment undertaking4.

With regard to UCP 600, sub-article 12(b), as noted, allows a nominated bank to discount its own deferred payment undertaking; however, this leaves open the question as to whether it allows a nominated bank to discount others' deferred payment undertakings, for example, one by the issuing bank. One may also ask whether it allows a nominated bank to discount, even though said bank has never incurred its deferred payment undertaking.

Conclusion

In sum, my view is that although sub-article 12 (b) authorizes a nominated bank to prepay a deferred payment undertaking, such an authorization does not seem to be an unconditional invitation for a named nominated bank to discount. It should be noted, however, that it's not uncommon for a beneficiary to request a nominated bank, one not having incurred its deferred payment undertaking, to discount. Yet the latest ICC preliminary opinion on TA 6905, although not ratified as of this writing, indicates that "by effecting a prepayment, without incurring their own deferred payment undertaking, the nominated bank is not protected by the content of sub-article 12(b)."

Before ICC issues a further clarifying opinion on sub-article 12 (b), to mitigate the risk of litigation banks should think twice before determining whether to discount within the scope of UCP 600.

Sheilar T. Shaffer is Documentary Manager of Import/Export Documents in the International Department of Agricultural Bank of China, Shantou Br. Her e-mail is sheilar@sina.com

1. ICC Publication No.680.

2. Collected Opinions Of the ICC Banking Commission 1995-2001 (ICC Publication No.632).

3. ICC Document 470/TA 655 rev (UCP 600). ICC Banking Commission meeting April 2008.

4. DCInsight, Vol.6, No.3, Summer 2000, "Contrasting UK and US Views of the Controversial Banco Santander Case"(by James G. Barnes).