Article

by Wang Xuehui (Ofei)

My article1 in another magazine concerning the case of China New Era v. Bank of China (Hong Kong) Ltd gave rise to a different opinion from Haluk Erdemol, a member of ICC's Turkish National Committee and a retired international bank manager.

In the article, I queried a decision from the Hong Kong Court of Appeal. The case concerned whether the negotiating bank was entitled to be reimbursed by the issuing bank if the documents were changed to be complying when they reached the issuing bank.

The argument focused on whether the negotiating bank could negotiate discrepant documents and later allow the beneficiary to correct them and make them complying before forwarding them to the issuing bank. It should be noted that the beneficiary "requested the [Nominated Bank] to negotiate/discount the drafts drawn by [Beneficiary] on the [Issuer] to the order of the [Nominated Bank] and 'relative documents even if they bear discrepancy(ies)' against an indemnity. Nominated Bank paid Beneficiary with recourse2."

The discrepancy(ies)

The cargo receipt indicated the goods name as "STN" instead of "TFT", making it discrepant. The beneficiary re-presented (a second presentation) the cargo receipt, but the second presentation was also discrepant. A third re-presentation corrected the discrepancy and appeared on its face to be complying. It was unclear from the evidence whether payment was made on the first presentation or second re-presentation, but it was ascertained that negotiation took place before the third representation. The issuing bank also determined that the FCB's presentation (FCB, the negotiating bank) was compliant after receiving the documents.

Mr Erdemol insists that a presentation can be cured after first presentation. In this case, however, the point was whether it had been made compliant within the time frame allowed for it. The subject L/C could have been available by a method other than negotiation and the outcome would have been the same, i.e., receipt by the issuing bank of a complying presentation. Hence, there was an obligation to reimburse triggered by subarticle 7 (c) of UCP 600.

Mr Erdemol further stated that my opinion that "Negotiation must be made on the day when documents are complying whether or not they have been corrected" was rigid and not in line with the spirit of the UCP and market practice. He also asserted that the opinion in the above case referred to a correction and replacement of documents as a "normal course of events". What's wrong, the argument goes, with a nominated bank's advancing while waiting for re-presentation as long as a complying presentation is made within the presentation period? FCB was deemed to have negotiated a complying presentation and, according to UCP 600, was entitled to be reimbursed.

It should also be noted that New Era (the applicant) obtained an injunction, but this was disregarded by both the trial court and the court of appeal.

The uncertainties

In the above-mentioned case, there are at least two uncertainties that deserve attention. The first is how correctly to understand the definition of negotiation in UCP 600. As per 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 [emphasis added], 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." The definition fails to indicate when the documents must be complying if negotiation is effected.

The second is that the nominated bank agreed with the beneficiary's request that the bank would negotiate/discount the drafts and relative documents against an indemnity even if the drafts contained discrepancy(ies). The uncertainty was whether the nominated bank, within the spirit of UCP 600, was obliged to accept the beneficiary's request, and even if the bank accepted such a request, whether it would bear the risks resulting from it.

The fraud conundrum

As Judge Le Pichon noted in the judgement: "no time frame is expressed in the definition of negotiation." If, as Mr Erdemol suggests, the correction and replacement of documents after negotiation has taken place is in the "normal course of events", how are the applicant and issuing bank to be protected if the facts reveal that a fraud has occurred?

The fraud issue is not governed by UCP but by local law, which always overrides the UCP. Even as a secure means of payment, an L/C cannot prevent fraud. But it is a matter of common sense, and generally a point of law, that if the applicant, the issuing bank or the nominated bank is aware of the fraud, it is entitled to refuse payment even if complying documents are presented.

There is, however, another side to the fraud exception. If the nominated bank, issuing bank or confirming bank has paid or negotiated in good faith, the payment cannot be stopped. Take the negotiating bank as an example: if it has already negotiated in good faith, the issuing bank must reimburse it even if fraud has occurred.

Then if, as Mr Erdemol contends, a negotiating bank can negotiate at any time, even if the documents are discrepant, provided the issuing bank receives complying documents after the correction, this could lead to a serious problem.

Suppose the negotiating bank negotiates the discrepant documents with recourse to the beneficiary but later makes the necessary changes to render the documents complying. When the issuing bank refuses to reimburse the negotiating bank, the latter may allege that it has negotiated in good faith and that the documents the issuing bank has received are complying. There is no time frame in UCP 600 to stipulate that negotiation must take place on the day the documents are complying.

One question would be how to make use of an injunction to manage fraud risks. Since nearly every nominated bank could confidently allege that it has acted in good faith, how is one to prove that it hasn't? On the contrary, if nominated banks are strictly required to act in accordance with UCP 600, the proof of "in good faith" would become easier. As stated above, if the negotiating bank truly negotiated the complying documents and is unaware of the fraud, its act is deemed to have been "in good faith". But if, as Mr. Erdemol and Judge Le Pichon's contend, since there is no time frame of negotiation, and if replacement or correction of documents can be made after negotiation, it becomes tougher to prove whether a nominated bank's act is in good faith or not.

Discovering fraud

I wonder whether this uncertainty can lead to cheating. As we know, fraud is common. When the beneficiary first presents documents to a nominated bank, the latter will find it difficult to ascertain whether fraud has occurred. The documents may be forged or their contents forged, and banks have no responsibility to look beyond how they appear to be "on their face".

Of course, the beneficiary is allowed to revise the documents until they are complying, even though this has never appeared in the UCP or ISBP. ICC Opinion TA 677rev asserts: "Until the documents are honoured or negotiated, they remain the property of the presenter." This has two implications: first, the beneficiary is entitled to correct its documents within the agreed time until they are complying, but also that the beneficiary must correct the documents before they are paid or negotiated.

To manage fraud risks and protect his customer (applicant), an issuing bank may choose to issue an L/C without any nominated bank, or the applicant may choose to apply for a straight L/C. If that becomes common, the function of trade finance using L/Cs would be seriously affected.

Conclusion

It's not an easy task to come up with a good solution to the negotiation problem. The question of whether or not to include the term in UCP 600 was settled when ICC national committees voted heavily to retain it. That being the case, it would be useful if the ICC Banking Commission could develop a detailed paper on the subject to clarify some of the unresolved issues that negotiation creates.

WANG Xuehui (Ofei) is a Lecturer in the School of Economics and Management at Anhui Agricultural University in Hefei, Anhui, China. Her e-mail is ofeiliya@ hotmail.com.

1. See Documentary Credit World, November-December 2011 page 34.

2. See the 2009 Annual Review Of International Banking Law & Practice, pp. 411-412. Insurance