Article


by Roberto Bergami, CDCS

This article aims to provide additional commentary to the article by T.O. Lee. As Mr Lee points out, the Rotterdam Rules (the Rules) will be a challenge for exporters, importers, insurers and banks. It appears that issues surrounding banking practices and letters of credit have received little attention so far. This article considers two contentious issues: volume contracts and derogations and negotiable electronic transport records.

Volume contracts and derogations

The real issue with volume contracts is the allowable derogations from the Rules. Whilst certain obligations cannot be excluded, such as making and keeping the ship seaworthy and properly crewed, equipped and supplied, Article 80.1 allows for derogations from the Rules for volume contracts, stating "... a volume contract to which this Convention applies may provide for greater or lesser rights, obligations and liabilities than those imposed by this Convention". In practice, this means that two sets of freight rates will be available in the market: one applying to standard contracts (without derogations) and the other applying to special contracts (with derogations) that offer cheaper freight rates, but with diluted carrier liability.

The shipper and/or other relevant party is presumed to have sufficient knowledge to understand the ramifications of derogations and the consequent increase in risk. If the carrier reduces its liability, the shipper (or other relevant party) must assume an increase in liability and risk.

Cargo insurance may offer a solution to this shift in risk, but only when the insurer, after having considered the derogations, decides to offer the insurance. Moreover, if insurance is available, it will be at an increased cost, and this may reduce or nullify the effect of any likely reduction in freight rates.

Letters of credit

Derogations may have a significant impact on letter of credit operations. Currently, a contract of sale is executed and, when payment is by a letter of credit, the applicant subsequently lodges the application with the issuing bank. The issuing bank evaluates the application, considers its risk position and either declines or accepts the application and issues the L/C accordingly. Security is taken by the issuing bank, but as this is often at less than 100 per cent of the L/C's par value, the issuing bank assumes some financial exposure.

The documentary requirements of the letter of credit are of particular interest when a classical negotiable bill of lading (B/L) is demanded. For example, in CFR or CPT Incoterms 2000 contracts, the beneficiary must provide a transport document - a B/L - and additionally provide evidence of insurance under CIF or CIP contracts. The issuing bank uses the B/L as a form of security and commonly has this consigned "to order" or "to the order of the issuing bank, for the account of the applicant". The issue of negotiability is discussed in the next section, in the context of electronic records.

Under the currently used conventions for the carriage of goods by sea, a departure from carrier liability is generally not possible; therefore, there is a predictable trading environment, with well-established carrier liability and insurance practices. Consequently, the security of the B/L is normally accepted by bankers.

Derogations

Derogations will be challenging to the banker, because in accepting these, the value of the B/L may be weakened. In addition, it will be very difficult for the banker to ascertain the impact of derogations through documentary checking. The banker is no more an expert in carriage of goods contracts or cargo insurance than a carrier or an insurer is an expert in banking matters. Yet the issuing bank may well be forced to take a position on derogations, because the B/L will form part of the documentary requirements.

In practice how can the applicant ensure that there are no derogations to contracts of carriage? And if derogations exist, how can the applicant be satisfied that the cargo insurance cover is adequate? Moreover, how does the banker protect the value of the B/L it holds as security and ensure that insurance is adequately provided?

Derogations can only apply under the Rules if these have been explicitly agreed to by shippers and other affected parties. A volume contract with derogations must contain a prominent statement that it derogates from the Rules in accordance with Article 80.2(a). In practice, as described below, the changes mooted by the Rules may result in a recasting of letter of credit business flows and documentary checking.

Following the contract of sale and before the letter of credit application is lodged, traders will need to address the issues of derogations and insurance coverage with the carrier to the satis faction of the issuing bank; otherwise, the letter of credit application may be refused. Since the banker's role is limited to document checking, it seems logical that derogations will be addressed through documentary evidence, but what sort of evidence is required?

UCP 600

UCP 600 sub-article 14 (a) imposes an obligation on the banker to check only whether documents appear on their face to constitute a complying presentation. Sub-article 20 (a) (v) specifically states that the terms and conditions of carriage will not be examined. Consequently, the banker is likely to require that the carrier either certify on the front of the B/L that there are no derogations, or specify the derogations. Alternatively, a separate carrier-issued certificate could be issued to the same effect, but this would result in additional documentation and an audit trail to link the certificate to the B/L.

When insurance is provided by the beneficiary (CIF and CIP terms), the banker is likely to require the insurance document (policy or certificate) to specify cover against derogations. In practice, just exactly how this will be achieved to the banker's satisfaction remains to be seen, especially where it is the beneficiary itself that issues certificates of insurance under an open marine policy.

In these circumstances, it is difficult to imagine the banker being satisfied with certification by the beneficiary. If the L/C demands certification from the insurance company, the insurer needs to scrutinize each contract of carriage for derogations prior to the shipment of the goods and to be satisfied with the insurance coverage. This is likely to be resisted by insurers, thus resulting in a noncompliant presentation.

Negotiable electronic transport records

It appears that the Rules do not consider letter of credit business to any great extent. This is particularly the case when negotiable electronic transport records (documents) are concerned. Negotiable electronic transport documents are envisaged under the Rules, but this issue has not received enough consideration in the context of letter of credit trans actions. Electronic presentation of documents has been a possibility for L/Cs since the eUCP were released in 1992. However, eUCP usage continues to be minimal. In part, this can be explained for two reasons: the eUCP requirements themselves, that seem to place more burden on beneficiaries than traditional paper presentations, and the commonly held view of many smaller firms that do not believe there enough benefit is to be gained from investing in systems to make electronic document presentations feasible.

Electronic transport documents already exist, but these are nonnegotiable versions, and the notion of a negotiable electronic bill of lading (neBL) has difficulties in law and practice. Universal legal recognition of a neBL would be helpful, but at present electronic transactions are considered differently from one jurisdiction to the next. As a result, it is not clear how a dispute involving a neBL would be resolved.

Other challenges for the neBL are data security, transfer and accessibility. Data encryption systems are available, but their interoperability across different systems and industries has not yet reached the stage where universal generic applications are possible.

Making electronic negotiability work

In practice, how would electronic negotiability work? If a party transfers a record to a second party and that party adds its endorsement to the original record, does this create a new record? The addition of data would, of necessity, make it a different record from the original.

What happens when the record is subject to several transfers? BOLERO is probably the best example of an environment in which electronic records can be processed, including endorsements; however, this is an expensive service well outside the reach of many small firms.

For the neBL to be viable in an L/C transaction, traders, carriers, insurers and bankers would all need to be members of this system. It is unlikely this will happen.

In conclusion, the Rotterdam Rules aim to provide freedom of contract, but this freedom will come at the cost of certainty, particularly for smaller firms. Managing cargo risk will gain increased prominence under the Rules, and insurers will need to become more involved in assessing contracts of carriage and offering solutions. This means that business process flows are likely to change considerably, especially in letter of credit transactions.

In short, in the absence of an affordable solution for all parties involved in the movement of goods and the financing of trade, and in an uncertain legal international trading environment, it is difficult to see how a neBL can be feasible.

Roberto Bergami is Senior Lecturer, Practice of International Trade at Victoria University in Melbourne, Australia. His e-mail is Roberto.Bergami@vu.edu.au