Article

by John F. Dolan

Whether we like it or not, many well-intentioned lawyers and judges are unfamiliar with the day-to-day concerns of trade finance. Some, perhaps too many of them, see UCP 600 and the letter of credit and independent guarantee rules codified in civil codes and in the Uniform Commercial Code as special legislation fashioned to give banks the upper hand in bank/customer disputes and an easy way to justify dishonour. Show those critics the relatively low costs of these banking industry products - the UCP and statutory preclusion rules, short time periods, notice requirements and the tough liability burdens that the UCP and legislation impose on issuers - and they remain unconvinced. It is incumbent on those who regard the letter of credit, especially the standby and the independent guarantee, as crucial to trade finance and to domestic commerce to make the case for these commercial products.

A major misunderstanding among the critics arises when an issuer adds to the documentary requirements of the L/C a duty on the beneficiary to present the original of the credit. When the issuer rejects the beneficiary's argument that it misplaced the original, and when the beneficiary offers an explanation or a bond, the critics argue that the issuer that dishonours is using the strict compliance rule to avoid paying the beneficiary.

The critics say that as long as the issuer that knows the beneficiary is, in fact, the intended beneficiary, or as long as the issuer is protected by a surety bond supplied by the beneficiary to cover the issuer's losses occasioned by the missing original, the issuer should honour, the defective presentation notwithstanding. This article argues that, in most cases, the critics have no grounds to complain; usually the issuer has sound reasons to dishonour a presentation that does not include the original L/C.

Presenting party/beneficiary

The first valid reason is that presentment of the original to the issuer saves the issuer or nominated bank from having to ascertain that the presenting party is, in fact, the beneficiary. If a credit does not call for the original L/C, many issuers or nominated banks refuse to deal with the beneficiary in person. If the beneficiary presents himself at the issuer's counters with the required documents, the issuer tells him to go to his bank and present the documents through that bank, a bank that knows him. This policy, which banks follow to avoid paying someone falsely posing as the beneficiary, is understandable to anyone who knows that identifying a party is no easy task. Identification forces the issuer's document examiners to investigate facts not apparent in the documents, an investigation that entails time and expense.

Time and expense are the major costs the letter of credit and independent guarantee industry avoid in order to keep their prices low. They avoid the expense by limiting their decision to honour or dishonour by limiting the inquiry to documentary compliance. Adding those costs to these document-driven undertakings destroys the independence of the issuer's undertakings, rendering them suretyship undertakings, the quick, inexpensive independent undertakings' slow and expensive competitor.

This first reason applies, moreover, to confirmers and other nominated banks, that can rely on the beneficiary's presentment of the original letter of credit as a sound indication that they are honouring the beneficiary's drafts and not someone else's.

Honouring twice

A second reason for requiring presentment of the original L/C is to avoid having to honour the credit twice. A beneficiary who fraudulently represents that he lost or misplaced the original may, in fact, have presented the original to a nominated bank, or may plan to present it to a nominated bank after the issuer honours.

If the credit is available by negotiation and is not domiciled at a designated bank, the issuer does not know where the fraudulent beneficiary may have already negotiated, or may plan in future to negotiate his documents. Fraudulent beneficiaries cannot engage in that conduct if there is no honour without the original of the credit, which the issuer or nominated or negotiating bank will hold after honour.

Fraudulent changes and partial draws

A third reason for requiring the beneficiary to present the original of the credit is to guard against fraudulent changes in it. There have been cases in which the beneficiary makes fraudulent changes, even to a SWIFT-issued credit.

A fourth reason arises when the credit permits partial draws. This situation gave rise to the "notation credit", in which the issuer notes the partial draw on the credit and returns it to the beneficiary. If the beneficiary tries to present the original and obtain double payment, the nominated bank will see the notation and refuse to pay the beneficiary twice.

Surety bonds

The argument that issuers or nominate banks should accept surety company bonds in lieu of the original is often unpersuasive. It reflects a serious misunderstanding of the nature of the independent undertaking. If the issuer or nominated bank knows the surety and is satisfied that the surety will reimburse the bank in the event of a fraudulent draw, banks should, nonetheless, reject the suretyship substitute. A claim against a surety is usually not a substitute for the assurance that the bank is paying the beneficiary and that it will not face a second draw on the credit.

Making a claim against the surety can be time-consuming and expensive. Traditionally, sureties refuse to pay until the insured proves it sustained a loss. That proof is fine if you have a large dollar claim and lawyers who work for little compensation. And even in this case the issuer will have to wait for the surety to honour the claim, for the surety will investigate the transaction to satisfy itself that the bank's claim is honest. That process takes time, and time in independent undertaking transactions must be short; independent undertakings cannot support lengthy factual inquiry. The whole point of the undertaking's independence is to promote celerity and certainty, both of which suffer when a surety has to ascertain the validity of a claim on its bond. Issuers should have the right to issue a replacement original, but if they do, they should insist on a cash bond and not on a suretyship undertaking to make the issuer whole in the event of loss.

Bank hesitations

One might wonder, given this state of affairs, why banks do not always require presentment of the original of the letter of credit or guarantee. For one thing, banks do not want to clutter the document examination process with unnecessary documentary requirements. To require presentment of the original credit as a matter of course violates that precept.

Banks should add the requirement only when they need it. Sometimes, perhaps often, they won't need it. If they know the beneficiary, who could well be the issuer's customer or a party with whom the issuer has otherwise dealt, there may be no good reason to add the requirement.

Often, there are no nominated banks and no risk that the beneficiary will present his documents at any place other than the issuer's counters. In that case, the reasons for the requirement diminish. With electronic presentments, furthermore, the requirement that the beneficiary present the original of the credit defeats the whole purpose of using them. In short, well-counseled banks will not add the requirement if it is unnecessary or if it clogs their electronic practices.

Conclusion

If you are Hannibal trekking heavy siege equipment through the Alps, you need elephants. If you want to fashion quick payment mechanisms, you use commercial greyhounds. Independent undertakings are, by nature, the greyhounds of trade finance and domestic commerce. Issuers that require presentment of the original L/C are fashioning a mechanism that protects the quick, inexpensive nature of independent undertakings.

The law and its implementation by jurists and arbitrators should recognize the quite proper use of a documentary requirement that the beneficiary drawing on the independent undertaking should present the original undertaking itself.

John Dolan is Distinguished Professor, Wayne State University Law School, Detroit, Michigan in the US. His e-mail address is j.dolan@wayne.edu. Thanks to Alexis Meizoso and Chang Soon Thomas Song for their assistance with this article.