Article

by Glenn Ransier

Ask many US bankers, regulators and other legal professionals about guarantees and the probable response would be: "US banks cannot engage in guarantee transactions. We conduct trade business utilizing letters of credit." While the latter sentence is factual, the former is not entirely correct. US laws were crafted with L/Cs in mind, and the specific laws that govern them are found in the Uniform Commercial Code (UCC), Article 5 (revised). Yet the laws apply to any transaction, however named, that is: (1) an "independent"* obligation of the issuer and (2) "documentary in nature". The definition of an L/C as provided in New York's UCC Article 5-102 (10) is: "Letter of credit means a definite undertaking that satisfies the requirements of Section 5-104 by an issuer to a beneficiary at the request or for the account of an applicant or, in the case of a financial institution, to itself or for its own account, to honor a documentary presentation by payment or delivery of an item of value."

With this as the background, US banks may engage in transactions that incorporate either: (1) UCP 600; (2) ISP98; or (3) URDG, as these rules mandate that an issuer have an independent obligation to effect a payment solely upon the determination of a compliant documentary presentation.

Suretyships

As reflected in the National Bank Act, US banks cannot typically enter into guarantees that act as a suretyship (a.k.a. secondary or accessory) transactions whereby the issuer is mandated to look beyond the face of any required document and decide upon or investigate extrinsic fact(s). Because the US market so closely associates the word "guarantee" with a "suretyship" contract, even those who are proponents of guarantees avoid processing them, for to do so is to invite challenges by others, including auditors and regulators. Bankers would be forced to constantly explain and educate different factions that a URDG guarantee or counter-guarantee is a letter of credit as defined in UCC Section 5 and not a suretyship governed by the commercial or regulatory laws applicable to suretyship types of guarantees.

However, whereas the US is recognized as being L/C-focused, a significant number of other countries have, prefer and utilize laws that cater to guarantees. The US limited focus has hampered our ability to engage in some lucrative trade transactions including, but not limited to, those secured by The World Bank which, on its website, states: "Note on the March 2003 Revision: The Bank's Forms of Bid Security (Bank Guarantee), Performance Security and Bank Guarantee for Advance Payment have been revised to incorporate the ICC's Uniform Rules for Demand Guarantees (URDG). We believe that use of these new forms will benefit both our clients and the business community."

URDG revision

As past articles in DCInsight have discussed, the ICC Banking Commission has given its approval to modernize the current URDG 458, and this may provide the impetus to begin the re-education of the US marketplace. Despite the limited US use of the present URDG, the US voted in favour of the URDG revision. The URDG Drafting Group Chair, Georges Affaki, has a compelling vision for the revised URDG. In addition, Donald Smith (see the "Expert commentary" in this issue), as a member of the URDG Task Force, is commenting on the proposed draft revisions, and together we are inviting and gathering comments from the US Council for International Business, bankers and corporate organizations. We recognize that URDG guarantees provide US banks with another trade product offering for their clients and an opportunity for new revenue streams.

The proposed URDG revision offers a new opportunity to harmonize international rules and expectations. This will help avoid the various pitfalls of relying on local individual, country and legal practices. The Drafting Group approach is to align the URDG in large part with UCP terminology and practice, and to apply the knowledge learned from past queries and ICC Banking Commission Opinions. This will, I believe, make the URDG more attractive to US users and parties in other countries. The following highlights just a few of the many fundamental benefits under the proposed URDG revision:

1. Definitions. The grouping of definitions and their similarity, where possible, with those of other ICC rules will greatly benefit all users.

2. The continued ability to establish governing laws and jurisdiction upon issuance. For anyone who has ever had to litigate a trade finance dispute, the ability to choose upfront the governing law and the competent court should be able to save parties years of court struggles and significantly reduce litigation fees.

3. Despite a few exceptions, the new URDG will provide document examination rules that strike a balance between arduous review duties while, at the same time, assisting in the elimination of fraud. The intent of the URDG has always been for a beneficiary to provide a simple documentary demand for payment. However, it must be recognized that, with increasing regularity, the applicants are requiring some kind of documentary proof to support a demand, i.e., a copy of a B/L in a commodity transaction or a legal notice of some sort. While guarantors may attempt to discourage this practice, they still want to avoid fraud and to protect themselves and their clients from needless litigation. The presentation of additional documents provides guarantors the opportunity to establish a clear and obvious fraud while a simple demand may mandate its unwarranted payment and place the guarantor or its client in a legally untenable situation. Thus, the expansion of review procedures for types of documents other than simple demands is desirable.

4. The inclusion of advising parties and their roles and the expansion of the amendment rules.

5. The allowance for different drawing presentation methods (i.e., either in paper form or electronic and capable of being reproduced in tangible form) and the establishment of specific actions for the payment of a drawing or its refusal.

While the introduction of "international standard demand guarantee practice" has drawn some limited criticism, I believe the benefits of defining what "international" practices are and proposing that guarantors comply with these rather than local or specific bank practices adds value to the rules and aligns then with the above-mentioned ICC publications. If guarantors adhere to the international practices, the revised URDG will add to its success.

There is attractive long-term potential in aligning URDG and UCP and providing maximum transparency for all parties as well as for the various regulators. The trade industry continues to grow, and exciting new products and services are surfacing everywhere. The future success of each organization's trade strategy and its value-added services must be to expand. While the US market is doing reasonably well in international trade, it could and should take action to successfully implement the coming URDG as a valued product offering.

Glenn Ransier is a member of the URDG Drafting Group, the Banking Committee of the US Council for International Business and the former Chair of IFSA US National Commercial L/C Committee. He is a FIG Product Head, Trade Operations with Standard Chartered Bank, New York and the former Global Trade Products Operations Manager with American Express Bank Ltd. The views expressed herein are his own. His e-mail is glenn.d.ransier@aexp.com

*UCC Article 5-103 (revised) provides an overview of an issuer's commitment as: "(d) Rights and obligations of an issuer to a beneficiary or a nominated person under a letter of credit are independent of the existence, performance, or nonperformance of a contract or arrangement out of which the letter of credit arises or which underlies it, including contracts or arrangements between the issuer and the applicant and between the applicant and the beneficiary."