Article

by Mohammad Burjaq

When UCP 500 was approved in the middle of 1993 and later came into force on 1 January 1994, I was still involved in academic studies. Consequently, I missed the opportunity to observe how the Middle East received and interpreted the rules 13 years ago. Fortunately, I began my first job in November 1994 in an export letter of credit department; ten months after UCP 500 came into force. This opportunity encouraged me to read and thoroughly analyze the provisions of the new rules, a task in which I was considerably helped by a comprehensive reading of the ICC Opinions and some court decisions on related matters. This selftraining taught me a great deal about how to understand and apply the UCP. Thirteen years ago, most banks in the Middle East, as well as corporate customers and other players in the field, spent considerable time educating staff about best practices and how to avoid abusive use of the rules that might lead to severe conflicts between parties involved in L/C operations.

Middle East economics

The political instability and the increased volume of import and export business in the Middle East, both between countries in the region and internationally, were factors influencing the commercial parties to use L/Cs as a mechanism of payment. The broad use of this product by the banks, buyers and exporters as a secure payment method required that they fully understand it. Another factor was the increasing number of letter of credit transactions tainted by fraud. This affected some financial institutions in the region, as well as their customers, and prompted banks to adopt new procedures to mitigate the risks of fraud.

National committees in some Middle Eastern countries played a pioneer role in urging national institutions to have a better understanding of UCP 500. The interactions between regional banks and ICC national committees, in particular, achieved significant results.

These and other actions combined to place most Middle Eastern countries in advance of other countries looking to improve their understanding of the UCP to better serve the interests of all the parties concerned.

Action on UCP 600

When the revision of UCP 500 got underway, a number of financial institutions in the Middle East reviewed the ICC Banking Commission Opinions and the legal cases that had addressed the application of the rules. During the revision process, their feedback was sent to the UCP Drafting Group up until the time the final draft of the new rules was approved. To supplement this input, a number of seminars on the revision were conducted by national committees and other institutions in the banking sector to update all parties involved and to provide them with insights into the likely changes.

Sub-article 12(b)

Now that the rules have been approved, some L/C experts in the region have raised certain concerns. The first of these points involves sub-article 12(b) dealing with the discounting (prepay or purchase) of drafts and/or documents under acceptance or deferred payment L/Cs. Under this subarticle the issuing bank authorizes the nominated bank to prepay or purchase the accepted draft or deferred payment undertaking. This provision was included due to the impact of the well-known legal cases of Banco Santander SA v. Bayfern Ltd. and Credit Lyonnais v. Canara Bank, in which the confirming bank sued the issuing bank for reimbursement. The issuing bank defended on grounds of fraud by the beneficiary made known to the banks before the maturity of the deferred payment undertaking incurred by the confirming bank (as in the Banco Santander case) and the French decision refusing to protect Credit Lyonnais that discounted its accepted draft (bill of exchange).

In both cases, the courts held that beneficiary fraud gave the issuing bank a defence against the confirming bank's claim for reimbursement and that the confirming bank, when it discounted its deferred payment undertaking or its accepted draft, took the risk that beneficiary fraud would be made known to the banks before maturity.

The problem of course, was the failure of UCP 500 to address the implication of making a deferred payment undertaking and not authorizing prepayment of deferred payment obligations or discounting of acceptances.

These two cases and others sharpened the debate over protecting the nominated bank's discounting of a deferred payment undertaking from subsequent claims of beneficiary fraud. Consequently, UCP 600 tried to find a way to mitigate the fraud risk and to simplify the payment process. However, many Middle Eastern commentators believe the provision of the new subarticle 12(b) gives rise to a real risk that the issuing bank, which is committed to honour the nominated bank's claim, may not be able to reimburse itself from the applicant when the fraud is found before maturity but after the purchase or prepayment by the nominated bank. This risk is heightened by the provisions of sub-articles 7(c) and 8(b), which impose reimbursement obligations on the issuing and confirming banks respectively.

It may be that we will have to devise a solution for the above problem. One possible solution might be to exclude subarticles 7(c), 8(c) and 12(b) and to request a prior authorization to discount any acceptance or deferred payment credits. Another would be to incorporate a provision in the standard agreement between the issuing bank and the credit applicant under which the applicant agrees to reimburse in respect of any discounted payment, even if fraud is made known to the banks before maturity. In any case, the solution is likely to vary from one bank to another.

Article 16

On other issues, bankers in the Middle East believe the new UCP is likely to prevent disputes. In particular, they tend to look positively on article 16, Discrepant Documents, Waiver and Notice, particularly sub-article 16(c), which includes four options concerning the disposition of documents when the issuing bank refuses to honour. Among these are permitting the issuing bank to refuse discrepant documents and hold them until it receives the applicant's waiver and accepts it, or to hold the document until it receives further instructions from the presenter. The fact that these options are now expressly set out in the UCP should discourage banks from including individual wording on these points in their L/Cs or notices of refusal, a practice that has been criticized by the ICC Banking Commission.

Other UCP provisions

We also look with favour on sub-article 14(j), which states that the addresses of the beneficiary and applicant need not be the same as those in the credit. This should eliminate a number of needlessly claimed discrepancies. Moreover, we approve of the clarification in UCP 600 article 6 concerning availability and place for presentation, which states that an L/C available with a nominated bank is also available with the issuing bank. This will clear up misunderstandings of some banks in the Middle East that consider the documents received from a bank other than the nominated bank to be discrepant presentations.

Future work

The years to come will reveal how my region accepts the new UCP with all its pluses and minuses. But we appreciate that the UCP Drafting Group, the Consulting Group, national committees and ICC Paris have worked very hard to produce the best revision possible.

Accommodating UCP 600 will require a massive restructuring by all parties concerned, as well as effective training to help understand the new rules. In this, the Middle East is no different from other regions. The exercise will be difficult because articles with new provisions have been introduced and others have been removed. Banks will also have to enhance their systems, for example, to deal with the four options concerning refusal of documents and the maximum of five days permitted to determine whether a presentation is a complying one.

In fact, all institutions involved in the L/C business will have to work continuously to improve their employees' knowledge so that misunderstandings in interpreting these rules can be minimized and disputes, at least in the majority of cases, can be avoided.

Mohammad Burjaq, a member of the UCP Consulting Group, is Trade and Foreign Operations Manager at Jordan Commercial Bank in Amman, Jordan. He is also a member of ICC Task Force on Guarantees and of the ICC Banking Commission. His email is cdcsmmb@yahoo.com