Article

Sub-article 12 (a)'s impact on banks

by N. D. George, CDCS (Distinction)

Can a nominated bank that is not a confirming bank end up in the same position as a confirming bank and find itself forced to make payment, incur a deferred payment obligation/acceptance or negotiate without recourse to the beneficiary?

The answer to this question should be "no" because of article 8 of UCP 600, under which an obligation to pay, incur a deferred payment undertaking/acceptance or negotiate is applicable only if the nominated bank had added its confirmation to the credit. But is that the end of the story as far as a nominated bank is concerned, or is there room for giving another spin to the perception that absent confirmation there is no obligation?

Let's take a look at sub-article 12 (a): "Unless a nominated bank is the confirming bank, an authorization to honour or negotiate does not impose any obligation on that nominated bank to honour or negotiate, except when expressly agreed to by that nominated bank and so communicated to the beneficiary [emphasis added].

The above sub-article makes it clear that, just like a confirming bank, a nominated bank can become obligated to the beneficiary under a credit that is not required to be confirmed. What is meant by "obligation"? Unfortunately, article 2 ("Definitions") does not help, as this word has not been defined there. Before rushing to a dictionary, let's examine where else in UCP 600, in relation to banks, the word "obligation" appears.

In sub-article 13 (c), this word is used to denote the issuing bank's obligation to provide reimbursement, and in sub-article 38 (a) it is used to highlight the fact that banks have the choice not to effect the transfer of a transferable credit. In the context of UCP, the word "obligation" can therefore be interpreted to denote the imposition of a liability on the part of the bank, so that, with regard to providing "reimbursement", the issuing bank is liable, while with regard to agreement to effect transfer, the bank is not liable. As far as the dictionary meaning goes, an "obligation" is something one is required or compelled to do by law, rules or custom.

"Expressly agreed"

What is meant by "expressly agreed"? Here again, UCP 600 has not provided any guidance as to how and under what conditions any written statement is to be deemed an "express agreement". In the absence of this, one is required to fall back on the meaning one gains from reading language used in the covering letter most banks use when advising another bank's credits. Most banks make sure to mention that credits do not bear their confirmation or that they are advised without engagement or a combination of both. This should be sufficient to put the beneficiary on notice that payment or acceptance or negotiation is left to the discretion of the nominated bank. But what if a bank, out of overzealousness or sheer ignorance, adds statements such as: "We shall negotiate documents presented under this credit" or "We shall negotiate a complying presentation", etc.? Statements such as these are as close as one can come to declaring one's intentions "expressly".

Binding the nominated bank

Inappropriate use of language such as the above carries the potential to bind the nominated bank into acting on its nomination when it really did not mean to be so obligated. In my view, a bank that used similar language when advising its credits would be precluded from refusing to honour or negotiate, or to negotiate but to impose "recourse" as a condition, when a complying presentation is made. If the intention of the nominated bank was that the service of "honour" or "negotiation" would be provided only on a with recourse basis, then that intent must be made clear in its advice. Advising banks, therefore, have to be careful about the selection of words; otherwise they will suffer unintended liability, and they will be compelled to honour or negotiate a presentation of conforming documents under credits they have not confirmed.

In these times of uncertainty, when a number of banks have folded and no one knows who is in line to be next, it is all the more important for advising banks to get their acts right. A smart beneficiary of an unconfirmed credit will read the advising bank's "letter of advice" word for word. If anything resembling an "express agreement" is contained in the covering letter, the advising/nominated bank could be in for a lot of trouble.

Rights vis-à-vis issuing bank

Following the above analysis, one can reach the conclusion that under sub-article 12 (a) the "obligation" to honour or negotiate is applicable equally to both the confirming bank and to a nominated bank having expressly communicated to the beneficiary its agreement to do so. Both stand compelled by rules or custom (UCP in this case) to perform an obligation. But what about the rights of these banks vis-à-vis the issuing bank? While UCP 600 goes into considerable detail to explain confirmation, there is no corresponding explanation with regard to a nominated bank that expressly agrees and so communicates this to the beneficiary. Dissecting sub-article 12 (a) further, it appears that this sub-article has introduced an additional category of nominated bank. Articles preceding article 12 introduced readers two categories, viz:

1. a nominated bank that does not add its confirmation to the credit; and

2. a nominated bank that adds its confirmation to the credit.

The third category I see in sub-article 12 (a) is what I will call a category 3 bank, namely a nominated bank that adds its express agreement and communicates the same to the beneficiary. The question is whether the position of such a bank is different from that of Bank No. 2 above insofar as its rights vis-à-vis the issuing bank are concerned. While there is no doubt that Bank No. 3 has the same obligation as Bank No. 2 and remains committed to the beneficiary, it is unclear, to say the least, whether the rights of both categories of banks are the same.

There are two issues to be considered here. As to the first, when a credit is to be confirmed, there is always a request or authorization from the issuing bank to the nominated bank asking the latter to add its confirmation. But no such request from an issuing bank is required in UCP 600 for a nominated bank to "expressly agree and communicate to the beneficiary". Issue two is that article 8 and its sub-paragraphs in UCP 600 only cover the undertaking of the confirming bank. Therefore, Bank No. 3 will be hard-pressed to prove its claim against an issuing bank, its administrators or liquidators as being equal to that of a confirming bank, as it has only sub-articles 12 (a) and 7 (c) to rely on.

Implications

What are the implications if the rights are not the same as those of a confirming bank? In the normal course of events, risk, if any, will be minimal provided the documents comply. But in the event the issuing bank goes belly-up, the risk could be far different. Would the liquidators accord to Bank No. 3 the same ranking as Bank No. 2 as creditors of the issuing bank if reimbursements for documents taken up by these banks were pending prior to the demise of the bank, or would they be treated differently if these banks were forced to take up documents after the demise? In terms of ranking, I would think the liquidators would have no hesitation accepting a confirming bank's claim to priority. But it would be a hard sell for Bank No. 3 with respect to documents that it was forced to take up.

If the position of Bank No. 3 carries the risk of getting subordinated to that of Bank No. 2, what is the use of having a provision in sub-article 12 (a) reading: "except when expressly agreed to by that nominated bank and so communicated to the beneficiary"? This can be effectively relied on as the provision that supports what's known in the market as "silent confirmation", where the nominated bank (sometimes a bank unconnected with the credit) adds its confirmation as a separate arrangement with the beneficiary. Though silent confirmation is not mentioned in the UCP, the rules do not prohibit banks from creating ancillary business/service opportunities around a credit by those prepared to assume the risk. It can be argued that the statement "except when expressly agreed to by that nominated bank and so communicated to the beneficiary" tacitly recognizes the possibility of silent confirmation, i.e., confirmation without a request or authorization from the issuing bank.

Banks active in silent confirmation can use this particular article to silence their internal and external auditors if the latter take the line that silent confirmation is against the UCP rules. However, when banks unconnected to the credits add their confirmation, they need to be aware that they will not receive the same protection as that of a nominated bank in case the issuing bank refuses reimbursement, for example by alleging fraud in the underlying transaction. It is therefore advisable for unconnected banks to enter into a risk participation with the nominated bank rather than to silently confirm credits directly to the beneficiary. Risk participation would ensure that the bank that honours or negotiates will be the nominated bank and hence protected against claims of fraud prior to reimbursement by the issuing bank.

N.D. George is a Vice President at Arab Banking Corporation, BSC, Kingdom of Bahrain where he heads Loans and Trade Finance Operations. His e-mail is cochin1949@gmail.com. The views expressed in this article are the author's and do not necessarily represent those of Arab Banking Corporation, which accepts no liability for them.