Documentary Credit World

For the 24th consecutive year, the Institute of International Banking Law & Practice conducted its one-day Americas Letter of Credit Law Summit. This Executive Summary provides an overview of topics discussed and debated by leading professionals at its 2023 event hosted by Hogan Lovells in New York and conducted as a hybrid event.

Trends in Trade and  Capital

Is the industry really ready for eTrade? The opening panel first took up this question and acknowledged that digitalization of trade requires security, the ability to transfer, and a coordinated effort among all stakeholders. Swift could be the mechanism to bring all parties together. To date, legislation based on or influenced by the 2017 UNCITRAL Model Law on Electronic Transferable Records (MLETR) has been adopted by just eight jurisdictions, illustrating that there is considerable room for improvement if countries are to foster a positive environment for electronic trade.

Amendments to the US Uniform Commercial Code and a new UCC Article 12 (Controllable Electronic Records) have been proposed which provide new default rules to govern LCs and other transactions involving emerging technologies. Thus far, about 10 US states have adopted the amendments and new Article 12, although New York is not one of them. At present, there are only three ways to issue an LC: by signed paper document; by agreement among the parties; or by standard industry practice. To issue an electronic LC, not all parties appreciate what the process entails. Of critical importance, it assumes you have a reliable system for control of the electronic record. In a dispute, one party could challenge that the instrument was not issued on a reliable system.

The 2023 UK Electronic Trade Documents Act provides that it overrides other laws in this area. Every country is starting with domestic law, but how to make it international is a challenge. You cannot contract out of local law. As seen in the effort to formulate the URDTT, there is a movement to draft rules prospectively, instead of rules based on existing practice. Other panelists agreed that a major stumbling block toward digitization of transactions is attaining consistency of laws across countries.

Discussion then shifted to banks’ willingness to accept email presentation of documents under LCs. While some beneficiaries insist on it, banks are largely still hesitant to accept presentation of documents via email. One banker whose institution accepts e-presentations noted that they perform callbacks to a number mentioned for the beneficiary. Another specialist added that it is a good idea to reference the account number. Banks have to distinguish a drawing from any other document they may receive. For transfer or assignment, banks are not protected. Banks also need to ensure they have a strong reimbursement agreement.

The panel then addressed issuance of LCs where the applicant name is not the bank’s customer or the instructing party. In some situations, the LC applicant is the parent and LCs are issued “on behalf of” instead of “for the account of”. Banks should make certain their application is aligned with their reimbursement agreement. Banks must also consider if one company is allowed to incur debt for another. Panelists noted there are cases where customers go after banks, saying that they were not authorized to issue “on behalf of” another entity.

Although banks commonly deal with special deposit accounts whereby the person entitled to the money is only determined after a specific event or circumstance has occurred, the underpinning legal protections of such accounts are ambiguous. The proposed Uniform Special Deposits Act seeks to change that and is something trade bankers should think about. One panelist asked whether bankers should view special deposit products as complementary to, or competing with, LCs. The special deposit product is akin to a cash-secured LC, but it also has characteristics of an escrow, a trust, and a deposit account.

Pre-Honour Cases

In the US case, Motorola Solutions v. Hytera Communications, Hytera had been ordered to pay USD 49 million into an escrow account under terms of a court order. It delayed in doing so for about a year. To avert the court from holding it in contempt, Hytera argued that it needed more time to secure an LC from its Chinese banks to stay the order while it appealed. The court ruled that Hytera waited too long and that there were too many conditions it would have to meet to obtain the LC. The court also stated that it “has serious concerns about whether an unconditional letter of credit from a financial institution over which the court lacks personal jurisdiction is a strong enough provision of security”. Panelists noted the case raises important considerations regarding jurisdiction clauses and having a model supersedeas LC.

Proquip Ltd. v. Northmark Bank, involved an LC requiring presentment of the original LC and all amendments. Although the beneficiary had and presented the original LC, it did not have the original amendment and presented a photocopy. The trial court granted judgment for the beneficiary, but the appellate court reversed and entered judgment for the issuing bank. Panelists pointed out this is a sound result as the appellate court determined that under US UCC Section 5-108’s strict compliance standard and UCP600 Article 17(a) the issuer could dishonor the beneficiary’s draw. Panelists also referred to a 2010 article in which Michael Evan Avidon addressed a beneficiary’s option to refuse to accept an LC requiring presentation of the original LC.₁

The Singapore case, Winson Oil v. Oversea-Chinese Banking Corp., dealt with non-payment of LCs that OCBC and one other bank had issued to pay for gasoil that Winson Oil had sold to Hin Leong in circular transactions involving one other party. When Winson Oil presented letters of indemnity and invoices, the banks dishonored Winson’s claim for payment of more than USD 60 million under the LCs on the ground that the non-negotiable BLs were fraudulent, no oil was shipped, and statements in the LOIs used for presentations for payment under the LCs were false. In finding the fraud exception to have been established, the court determined that Winson Oil knew or should have known of the misrepresentations in the documents presented under the LC (i.e. applying a standard of recklessness).

Panelists said the trader tried to use LOIs, an unsecured promise to pay, instead of drawing down on the LCs. While LOIs are widely used in the oil trade business, one attendee stressed the importance knowing your customer and the nuances of the industry. For instance, there are transport documents not addressed in UCP that are routinely used in the industry. With this in mind, a BAFT paper was created in 2015, “The Oil and Gas Industry: A Practical Guide to Undertakings”.

In Sterling and Wilson Solar Solutions, Inc. v JPMorgan Chase Bank, an applicant was not entitled to injunctive relief against USD 47 million in LC draws which the beneficiary disputed by documenting claims that the applicant was in breach. For one panelist commenting on the decision, it is a good case for banks and beneficiaries where the applicant’s fraud argument was not very convincing.

In another injunction case, Strabag SPA, v. Credit Agricole CIB decided in April 2023, Strabag asserted it achieved substantial completion of its construction of a water tunneling system in Chile but the Chilean beneficiary disagreed and made a USD 16 million draw under the standby issued by Credit Agricole. Strabag sought a preliminary injunction against the draw which the New York Supreme Court granted, determining that Strabag established a likelihood of success on its claim of material fraud, demonstrated the danger of irreparable harm in the absence of an injunction, and that the balance of equities favored it. Panelists informed that the case is being appealed. (For an update, see p. 7).

A recently decided case, Aecom Technical Services, Inc. v. Credit Agricole CIB, which referenced Strabag and other decisions, illustrates the difficulty in showing fraud to enjoin an LC draw. Aecom involved draws on LCs backing local guarantees. When delays and problems occurred with an underlying project in Colombia, the beneficiary drew on the local guarantees and the local guarantor drew on the LCs. Aecom sought to enjoin the draws, but the court rejected all eight grounds raised by Aecom in attempting to show that it was not at fault for the delays and that the draws were otherwise improper.

Brief attention was also given to Experior Global Warehousing v. BTC III Hamilton DC LLC in which tenant/applicant  sought an injunction against a draw on the LC posted to secure the lease. The court determined that tenant/applicant  had not demonstrated irreparable injury and that their motion for a temporary restraining order failed.

Risk  Distribution &  Capital Adequacy Issues

Since the 2008 financial crisis, new regulations on capital adequacy have been imposed on banks which has forced banks to diligently evaluate their capital consumption and consequently their capital optimization. In this discussion, panelists examined the importance of risk-weighted assets (RWAs), strategies financial institutions (FIs) can employ to achieve capital optimization, and credit risk mitigation techniques a bank can utilize to reduce the credit risk associated with an exposure. Standbys, demand guarantees, and other assets are risk weighted based on applicable regulations and banks are pressured to reduce RWAs from a business standpoint to free up more capital. Avenues for capital optimization, among others, include: reduction of RWAs through funded and unfunded credit risk mitigation; syndication of loans with other FIs; and distribution of risk through use of a master risk participation agreement (MRPA).

One panelist noted that at a former employer, their bank’s strategy in the area of syndicated credit facilities was to act as agent for the lending group and lead the origination of credit facilities whereby they would collect the closing/origination  fees and then sell or participate out most of their positions. Other panelists added that regulations are impacting this business line because the fees are not what they once were. Panelists noted that MRPAs are being used, but also added that potential participants need to be mindful of cross border arrangements since some countries have very strict laws prohibiting risk participation or allowing it only in certain industries. Additionally, there will be increased need for legal opinions from law professionals to determine what constitutes credit risk mitigation and reduced capital levels that can be held for certain risk, as regulators can require a legal opinion to be provided on request. Because risk weighting for financial standbys is higher than that for performance standbys, it is advantageous to hold more of the latter than the former. The distinctions between the two categories are not as clear as one might think and some commenters noted that certain standbys that might be financial in nature can be worded as performance standbys.

Sanctions &  Fraud  Litigation

The panel reviewed several recent high profile court cases dealing with fraud claims and sanctions issues. In Celestial Aviation Services Ltd. v. UniCredit Bank, London Branch involving a series of standbys issued by a Russian bank on behalf of Russian companies leasing aircraft from Irish companies, the English court upheld the independence principle and determined that the confirming bank was obligated to make payment to beneficiaries and could not rely on UK, US or EU sanctions to resist payment.

In Kuvera Resources Pte Ltd. v. JP Morgan Chase Bank, N.A., an LC beneficiary sued a confirming bank that returned complying documents citing the sanctions clause included in its two confirmed credits. The Singapore trial court determined that the clause was valid, however the Singapore Court of Appeal reversed, concluding that the confirming bank could pay but did not due to its internal risk-based decision. The bank had performed extensive due diligence on the vessel in question and while it did ascertain that the vessel was beneficially owned by a sanctioned entity in the past, it could not determine that was the case when documents were presented.

In discussing these two cases, panelists raised the question whether the outcome in Celestial would have been different had the confirming bank used a sanctions clause. When sanctions matters surface and bring into question a bank’s ability to pay under an LC, panelists also suggested that banks are unlikely to take regulatory risk over litigation risk.

In PT Asuransi Tugu Pratama Indonesia Tbk v. Citibank N.A., a Hong Kong court found a bank liable to its customer for “unauthorised” debits of USD 50 million made by the customer ’s authorised signatories over a five-year span. Only eight years after the final transfer and account closure did the customer inform the bank of its authorised signatories’ dishonest conduct. One year thereafter, it sued. In finding the bank liable, the court determined that several warning signs were missed that should have signalled the transfers were unauthorised. Although not an LC dispute, the case illustrates important lessons regarding the extent of the duty of care that a bank can owe to its customer in ensuring authority for payment instructions and absence of a limitation period under which a customer can sue a bank for an alleged breach of that duty.

The panel also addressed two 2022 Singapore cases.₂  In Crédit Agricole, Singapore Branch v. PPT Energy Trading Co. involving the LC-backed purchase of oil that was, unbeknownst to the LC issuer, subject to a complex chain of “round-tripping” contracts tainted by fraud. (For case summary of the Singapore International Commercial Court decision, see Mar. 2022 DCW 14). In UniCredit Bank A.G. v. Glencore Singapore Pte. Ltd., the LC issuer sought declarations that its dishonour was proper due to Seller/Beneficiary  fraud or, alternatively, that the beneficiary breached letter of indemnity warranties rendering it liable to Issuer, but the court concluded the beneficiary did not defraud or deceive and that the issuer was not entitled to rescind the LC or to recover the payment it made to the beneficiary.

Post-Honour Cases

Panelists next discussed cases involving recovery of proceeds of LC draws and a case dealing with fraudulent transfers using of LCs.

In EFLO Energy v. Devon Energy Corp., the standby LC applicant, alleging fraud, sued beneficiary for recovery of draw proceeds, breach of warranty, and unjust enrichment. The court found that the draw on the standby was not wrongful as the required notice provisions under the sales agreement had been satisfied. The case also featured the erroneous naming of the beneficiary in the LC. Among the takeaways from this case is consideration of an issuing bank’s duties when a beneficiary demands a correction, but the applicant does not consent.

In Iberdrola Energy Projects v. MUFG Union Bank, N.A., the appellate court affirmed the trial court’s decision to allow applicant’s conversion claim against assignee issuing banks for proceeds of a USD 140 million performance standby LC which beneficiary had assigned the proceeds to the banks as partial collateral to secure USD 730 million in financing. Applicant alleged that the beneficiary and banks conspired to obtain the LC proceeds as “a windfall” and then converted them despite knowing that applicant was claiming a considerable amount for unpaid work. Beneficiary lost arbitration and was ordered to return to Applicant USD 260 million, including the LC proceeds. In discussing the case, panelists noted that on the key issue of conversion, the court was right to dismiss as it was not a proper cause of action. The banks have no standing to bring a US UCC Section 5-110 breach of warranty claim. Panelists also pointed out that the case is being appealed.

Foley v. UBAF involved allegations of a fraudulent LC scam involving “back-to-back” credits. Thirty plaintiff families had obtained final judgments against Syria for acts of terrorism against members and were seeking to collect them against defendant bank for fraudulent conveyance actions for laundering USD 2 billion through UBAF’s New York branch to Syria in violation of US Treasury sanctions. The New York court found that it had jurisdiction over UBAF for the claims at issue because of its purposeful availment of the New York banking system in connection with its scheme to conceal money laundering to sanctioned Syrian entities.

In Lavi v. Bank Negara Indonesia, pro se beneficiary sued the alleged LC issuer, claiming wrongful dishonor. Decided at the complaint phase, the court stated that it could not exercise jurisdiction over a bank owned by a foreign sovereign and further determined that beneficiary did not specifically identify a contract (i.e. commercial activity) that could satisfy the jurisdictional requirement that the claim occurred in or caused a direct effect in the United States.

Real  Estate Standbys

In discussing how and why LCs are used in real estate transactions, panelists noted that there are real advantages for using LCs based on credit, cost, and bankruptcy considerations. From a landlord/beneficiary  standpoint, if a tenant files for bankruptcy, the landlord can go outside bankruptcy and demand from the issuing bank. Another panelist added that real estate standbys are a good business line for banks because they are rather straightforward and rarely drawn upon.

Discussion then shifted to the status of LCs of a failed bank. In instances in early 2023 involving Silicon Valley Bank and Signature Bank, failed banks were sold and acquiring banks gave indications that they would handle the LCs. But what happens when a failed bank is placed under FDIC receivership? Panelists drew attention to the FDIC’s ability to deem LCs “burdensome” and subject to repudiation. In Lexon Insurance, LCs were treated as contracts that can be repudiated.₃  As a result of the uncertainty of how LCs of a failed bank are handled, many landlords are concentrating the risk in so-called “fortress” banks and no longer accepting LCs issued by small and regional banks.

Panelists also took up the scenario of a beneficiary receiving an LC from a bank which did not record issuance of the LC. Consequently, the beneficiary will have no claim. One panelist shared knowledge of this happening when a bank employee in the real estate area signed a large amount LC without the approval of the bank’s LC department. Although the LC was not on the bank’s books, it was nonetheless obligated. This fiasco prompted the bank to adjust its internal policies and begin using signature books to limit and control which bank personnel were authorized to approve LCs. Panelists then identified key points in the life cycle of an LC when a landlord/beneficiary  interacts with the issuing bank, including when an LC needs amended and when a landlord sells commercial property and needs to transfer to a beneficiary. The panel closed with discussion of reduction and cancellation provisions. Many leases provide for reduction of the LC over time, but this is not contained in the LC because it is treated as a contractual arrangement between landlord and tenant. In such cases, the bank pays on the face amount of the LC and makes no determination whether the reduction conditions have been satisfied. In this way, the beneficiary, not the applicant, approaches the bank for reduction. As regards use of a cancellation provision should a bank’s credit rating drop, panelists noted that such provisions are not commonly seen.

Supply  Chain  &  Receivables Finance

The final panel discussion focused on the steady uptick in use of supply chain finance. Previously, factoring was commonly seen within industries which might otherwise struggle with obtaining bank financing. Now, major corporates are selling receivables to attain lower interest rates and big buyers are leveraging their credit standing by relying on SCF programs for their suppliers who may not have solid credit. The panel presented and discussed how an electronic SCF platform can serve as a real-time clearing house for the purchase and sale of receivables on a discounted basis.

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