Article

by N.D. George

There is no doubt that the members of the Drafting Group and the Consulting Group have done a great job. We now have a new, more user-friendly UCP than the one it is going to replace come 1 July 2007. For practitioners, it comes as a big relief that they will be freed from the uncertainties of "reasonable time", have wider options to deal with discrepant documents, may finance deferred payment credits, etc.

One particular noteworthy change I would like to mention is the deletion of the provision relating to revocable credits. Its demise, though, was gradual when it should have happened a long time ago. According to earlier versions of UCP, a credit was deemed revocable if the credit did not say it was irrevocable. A major change occurred in the 1993 revision when it was decided that a credit would be deemed irrevocable if the credit was silent about it. Now the concept of a revocable credit is no longer mentioned in the UCP. While this is a commendable and long-overdue decision, I believe that a great opportunity was missed to make the UCP assert the sanctity of irrevocability to the fullest. I am referring to the retention of the old UCP 500 article 41, re-numbered as article 32 in UCP 600 and reading: "If a drawing or shipment by instalments within given periods is stipulated in the credit and any instalment is not drawn or shipped within the period allowed for that instalment, the credit ceases to be available for that and any subsequent instalment."

An instalment credit will have several schedules for shipment, while the validity date of the credit will usually be set as a certain number of days after the date of the final shipment instalment. According to article 32, if the beneficiary defaults in adhering to any schedule, be it the first instalment or any other, the entire credit will be automatically cancelled. How can such a provision coexist with the concept of "irrevocability" now stated in UCP 600? Does not this article offer a window of opportunity for an unscrupulous applicant to get out of an irrevocable credit before its expiry when several more subsequent instalments are remaining to be shipped and when there is still some time to go before the expiry date of the credit?

I have always believed that this article may lead inexperienced bank staff in particular to trip up at substantial cost to themselves and their employers. This is especially serious, since the proportion of personnel falling into this category will increase in line with the global reduction of experienced staff. Indeed, this phenomenon has been acknowledged by the UCP Drafting Group as one of the reasons for carrying out a revision aimed at producing an easily readable, straightforward, simple and user-friendly UCP. Moreover, in my more than 25 years in this line in India and the Middle East, both centres where the documentary credit has been and continues to be a popular mode of payment, I have rarely seen instalment credits.

Soundings

I have had occasion to ask experts about this particular article on several occasions during the past decade. Almost all said that the article is intended to take care of the interests of the applicant, and to that extent it was meant to appease and please those who generally perceived the UCP to be tilted heavily in favour of the beneficiary! But the documentary credit is a payment mechanism between two trading partners (who presumably trust each other) and not an instrument to distribute favours. In my view, if it is critical for an applicant that a given shipment schedule be maintained by the beneficiary with the precision of a Swiss watch, that condition would then assume deal breaker status and accordingly must be made transparent in the credit itself and not communicated through any UCP article. The applicant should make this known to the issuing bank by inserting a suitable clause in the credit application and by the issuing bank in its credit issued to the beneficiary. To the extent that this article helps the applicant avoid being transparent, it sadly acquires the status of a trap for the unwary.

From my long experience, I can say that for the most part both the applicant and the beneficiary learn about UCP provisions from their bankers, often when discrepancies are raised by banks. Imagine the plight of a beneficiary learning about this provision in UCP after it had missed the shipment for a first instalment by a few days and was advised by the bank that the credit is no longer valid. The letter of credit as an instrument of payment has been losing its share in international trade because of complexity relating to documentation and problems with discrepancies raised by banks. In my view, retention of article 32 will not help the popularity of the product, but will promote its decline, since those beneficiaries who get stung due to ignorance about article 32 will do everything they can to stay away from credits.

Other drawbacks

There are other reasons why article 32 is ill-conceived and should not have been retained:

1. Article 32 has nothing to do with the risk underwritten by the bank when issuing the credit. The bank will record the liability for the full value of the credit, because the assumption is that the beneficiary will comply with all of its terms and conditions, including requirements relating to instalments. Accordingly, the bank will be exposed to the full value of the credit until its date of expiry. A bank opens a credit with an intention to pay. That is the reason banks rarely return discrepant documents to the presenter. For a bank, a default in an instalment is a discrepancy. It should be left to issuing banks to determine that a late presentation is non-complying and to handle it as they would any other discrepant presentation. As far as the remaining instalments are concerned, the issuing bank's responsibility to honour a complying presentation should remain unaffected by a discrepant presentation made earlier. UCP 600 should have taken that position (i.e., exactly the opposite of the position taken in UCP 500) in order to keep the sanctity of irrevocability intact until the expiry date of the credit. Such a change would have brought harmony and alignment with the spirit of UCP 600, as reflected in other articles (as explained below).

2. Article 1 of UCP 600 defines a credit in the following way: "Credit means any arrangement however named or described, that is irrevocable and thereby constitutes a definite undertaking of the issuing bank to honour a complying presentation" (emphasis added). Further, sub-article 15(a) says: "When an issuing bank determines that a presentation is complying, it must honour" (emphasis added). These two articles underline the point that each presentation is to be viewed separately, i.e., one presentation may be not complying and one may be and the bank still has to honour the complying presentation.

3. Article 5 of UCP 600 states: "Banks deal with documents and not with goods, services or performance to which the documents may relate." It is quite clear from this article that it is the least of a bank's worries what impact, if any, a default in an instalment is going to have on the business of the applicant. The issuing bank issued the credit in the first place because it was ready to assume the liability for the full period of the credit.

4. Sub-article 5(d)(i) of UCP 600 states: "A credit must stipulate an expiry date for presentation. An expiry date stipulated for honour or negotiation will be deemed to be an expiry date for presentation." The implication of this subarticle is that it is inconsistent for a credit to lapse before its expiry date because of the occurrence of a default in a shipment instalment, for example while many more instalments are still to come under the credit. A more consistent approach would have been to stipulate that the beneficiary's right to payment will lapse in respect only of the instalment with regard to which the default occurred. Moreover, sub-article 5(d)(i) serves to emphasize that the beneficiary has an inalienable right to expect the credit to remain valid and to be able to make presentations until the stated expiry date.

5. Article 7 of UCP 600 states: "Provided that the stipulated documents are presented to the nominated bank or to the issuing bank and that they constitute a complying presentation (emphasis added), the issuing bank must honour." Here again, there is reiteration that an individual presentation is completely delinked from any past or future presentations.

6. Article 10 of UCP 600 states: "Except as otherwise provided by article 38, a credit can neither be amended nor cancelled without the agreement of the issuing bank, the confirming bank, if any, and the beneficiary." Article 38 refers to transferable credits and not to instalment credits. It is a mystery (which unwittingly adds to the trap factor) why a warning about article 32 was not included under article 10. In any case, in my view it is apparent that article 32 directly contradicts Article 10.

Questions

I am aware that the Drafting Group has to respect the wishes of the majority when it comes to retaining an article or modifying it. Accordingly it would seem that there were fewer ICC national committees who asked themselves the following questions:

(a) Must a credit be permitted to fall apart in its entirety consequent to a default regarding a single instalment?,

or

(b) Must a credit be permitted to remain available for drawing of the instalments yet to be drawn?

I wish national committees had taken a deeper look into this issue and had gone for option (b). To let the entire credit fall apart because of a default in one instalment is tantamount to saying that the credit can be cancelled unilaterally if the beneficiary fails to comply with an individual term contained in it. Such a doctrine, in my opinion, damages the principle of irrevocability underlying credit operations and has the potential to trap the unwary. I believe that this article is a relic of the past and should not have been carried over into UCP 600. Apart from that, UCP 600 is a work well done.

N.D. George (CDCS Distinction) is Head of Loan Administration, Trade Finance & Forfaiting Operations at Arab Banking Corporation in Manama, Kingdom of Bahrain. His email is george.devassy@arabbanking.com. The views expressed in this article are the author's own and do not necessarily represent those of Arab Banking Corporation, which accepts no liability for them.