Article

Signature verification by the issuing bank

by Chang-Soon Thomas Song

In the Winter 2000 DCInsight, I wrote about a trial court decision in Korea concerning the non-documentary condition regarding signature verification by an issuing bank in a letter of credit. The trial court had ruled that the said condition was invalid and ruled against the issuing bank. In the case, the negotiating bank presented inspection certificates to the issuing bank, and the issuing bank claimed that the signatures did not match those it had on file.

The verification of signatures on inspection certificates is often performed by the negotiating bank at the request of the issuing bank. The issuing bank sends the signature specimens to the negotiating bank, and the negotiating bank checks the signatures on the inspection certificate against the specimens at the time the documents are negotiated. In this case, the issuing bank did not send the signature specimen and also stipulated that it would verify the signatures itself after receipt of the documents.

It was argued that the negotiating bank should have checked the signature on the inspection certificate with the issuing bank via fax and that the beneficiary should have amended the verification condition. However, the court, using the good faith principle, ruled that since the above condition was a non-documentary condition and antithetical to normal letter of credit operations, it was invalid, and it was construed against the issuing bank.

Conditions in L/Cs

Despite the above decision, the practice of putting conditions in letters of credit does not appear to have abated. In the present article, I discuss the above decision which went up to the Supreme Court, as well as a similar case which also involved the same condition and which was decided by another panel of justices of the Supreme Court four days after the previous decision. The two cases were decided by different panels of justices.

Korea is a civil law country, and there is no rule of stare decisis (whereby the present holding of a court is binding on future cases with similar facts). But in general the holdings of the Supreme Court are respected by the lower courts on issues that had been previously decided.

Most bankers regard the verification of signature on inspection certificate by issuing bank as a documentary condition, since there has been a presentation of the inspection certificate. But the Korean courts regard the verification of a signature by the issuing bank as separate from the inspection certificate and consider it to be non-documentary.

The problem

When a letter of credit requires the signature on the inspection certificate to be verified by the issuing bank, there is likely to be a problem. The signature in this case is the signature of the applicant kept on file with the bank.

Such a condition is likely to be an attempt by the applicant to check the quality of the goods being imported. The issuing bank's verification of a signature is probably to ensure that there has been no forging of the applicant's signature by the beneficiary.

In such a case, the exporter and importer may not be sure about each other's credit-worthiness. Although the exporter is assured of payment once shipment is effected, the importer may be worried that he will not receive the goods in the condition he wishes.

Since the letter of credit does not provide a means for the importer to check the goods being shipped (an inspection by an inspection agency is a good alternative, but these inspection certificates are not often seen), he may decide to convince the exporter to submit to the importer's inspection. And the exporter, who will want to make the deal, may agree.

Seen from this angle, there is apparently nothing wrong. The goods will be inspected by the applicant and, if they are in order, the applicant will issue the inspection certificate and sign it. When it arrives at the issuing bank with the other shipping documents, the issuing bank will check the applicant's signature and make payment.

L/C as payment guarantee

Although the credit can require the presentation of a document issued by the applicant - say, for example, a final acceptance certificate issued by the importer with about 20 per cent of the contract amount after testing a machine that has been imported - such a requirement undermines the payment guarantee to the beneficiary, which is the heart of the letter of credit instrument.

When a letter of credit is issued and advised to a beneficiary with a condition requiring a document issued by the applicant, on one hand the issuing bank is declaring to the beneficiary that an L/C has been opened, but on the other that the said L/C is not effective since, without the document issued by the applicant, the beneficiary cannot receive payment. When letter of credit disputes arise, the issuing and negotiating banks may enter into discussions and, if the matter cannot be resolved, they may go to ICC for a DOCDEX Decision or to court for a judge to rule on the legal effectiveness of the condition in question.

Courts have ruled that the beneficiary should delete the said condition or, if it is not deleted, that it has to comply with it in order to receive payment.

Banking Commission view

The ICC Banking Commission takes much the same view. Banks are discouraged from inserting these conditions in a credit, but if they are inserted, it is up to the beneficiary to delete the condition or comply with it (ICC Banking Commission Opinion R 446 2000/2001).

In the Korean trial court decision of August 2000, the credit stipulated in its additional conditions that UCP 500 sub- article 13 (c) was to be excluded. The court ruled that, despite this, such a condition making effective a non-documentary condition undermined the essence of the letter of credit transaction as a transaction in documents only and was thus invalid.

In the appeal to the Supreme Court, although the plaintiff lost the case on the basis of another discrepancy regarding the date of the DHL courier receipt, the ruling of the trial court concerning the condition regarding signature verification by the issuing bank was not overturned (Supreme Court decision dated May 24, 2002, Decision 2000 DA 52202).

On 28 May 2002, four days after the Supreme Court decision, the Court delivered another decision by a different group of justices, this time speaking directly to the condition requiring verification of a signature by the issuing bank. Unlike the previous decision, where the credit expressly excluded UCP 500 sub-article 13 (c), no such additional condition was included in the credit.

In this latter case, the Court also recognized that issuing bank verification of the signature was a non-documentary condition. However, the Court further ruled that the condition was completely and clearly stated in the credit, that a need to avoid the forgery of the inspection certificate called for it and that there was agreement between the beneficiary and the applicant concerning it. Moreover, the Court said that the negotiating bank could easily comply with the condition by inquiring of the issuing bank about it, and that, although the condition was not desirable in light of the essence of the L/C transaction, it could not be said to be invalid. In addition, the condition also applied to the negotiating bank.

The Court did not explain on what basis the UCP 500 sub-article 13 (c) could be overridden in this case. Unlike the modification of a provision in the UCP - for instance, the stipulation of a presentation period which would modify UCP 500 sub-article 43 (a) (which does not require express exclusion in the credit) - the exclusion of a provision of UCP is required to be expressly stated in the credit. Distinct from the previous decision, this credit did not expressly exclude 13 (c).

Nonetheless, in both decisions, one delivered just four days apart, the Supreme Court considered the signature verification by the issuing bank to be non-documentary.

Conclusion

The letter of credit is an instrument assuring payment to the beneficiary once the goods have been shipped and the shipping documents presented in compliance with the terms and conditions of the credit. Any special condition which undermines the documentary nature of the L/C transaction or which hinders the beneficiary from receiving his just pay ment should be discouraged. The L/C was created for the beneficiary and, if it is to remain a reliable payment instrument, all special conditions making the payment insecure should be avoided.

Chang-Soon Thomas Song is Attorney at Law (Arizona), First Expert, International Dispute Resolution (Letters of Credit), Trade and Services Division, Korea Exchange Bank, Seoul, Korea. His email address is thomas@keb.co.kr and Thomas.Song@azbar.org

L/C negotiation - purchase of compliant documents only?

by King-tak Fung

It is a common banking practice that a nominated bank may negotiate discrepant documents against an indemnity, i.e., the negotiating bank purchases discrepant documents on the condition that the negotiating bank may demand a refund from the beneficiary if the presented documents are subsequently rejected by the issuing bank due to discrepancies.

However, article 2 of UCP 600 defines negotiation as the purchase of drafts and/ or documents under a complying presentation. Sub-article 7 (c) provides that "[A]n issuing bank undertakes to reimburse a nominated bank that has honoured or negotiated a complying presentation [emphasis added] ... ".

In a recent Hong Kong case, China New Era International Ltd (Plaintiff) v Bank of China (Hong Kong) Ltd. (1st Defendant) & Flexus Computer Technology Inc. (2nd Defendant) & First Commercial Bank, Ltd. (Intended Intervener), the negotiating bank effected payment to the beneficiary against an indemnity because of discrepancies identified in the presented documents. However, by the time the negotiating bank presented the documents to the issuing bank, these discrepancies were rectified, and the issuing bank determined that the documents were compliant and did not issue a refusal notice. Hong Kong courts were asked to decide whether negotiation of discrepant documents before presentation of documents to the issuing bank would jeopardize the negotiating bank's right of reimbursement by the issuing bank.

Background

Parties

Transaction flow

1. The L/C called for a cargo receipt issued by New Era and the signature and chop on any cargo receipt had to be verified against the specimen copy of its authorized signature and chop provided by New Era to BOC.

2. Ching Tai instructed New Era to issue the first cargo receipt showing a wrong goods description and sent it to FCB by DHL. FCB received the first cargo receipt on 25 June 2008.

3. One the same day, Ching Tai instructed New Era to send a second cargo receipt that again showed a wrong goods description (which was different from that of the first cargo receipt) to FCB by DHL.

4. On 26 June 2008, FCB paid Flexus, the beneficiary, against the first cargo receipt subject to an indemnity.

5. On 1 July 2008, FCB mysteriously received a third cargo receipt by DHL. It appears that the third cargo receipt was handed to DHL by someone in Hong Kong on 30 June 2008. However, New Era alleged that it had never sent (and was never requested by Ching Tai to send) the third cargo receipt.

6. On 2 July 2008, FCB sought reimbursement from the issuing bank by presenting documents (including the third cargo receipt). BOC did not send any refusal notice.

7. New Era contended to the issuing bank that Flexus was acting fraudu lently, as it had never shipped any goods to New Era. New Era then obtained an injunction enjoining BOC from paying FCB.

New Era did not press charges for forgery in the summary proceeding, as it accep ted that, if the third cargo receipt was com pliant and FCB was entitled to present the same, it was irrelevant if the document was forged. This was because FCB had no knowledge of fraud by Flexus until long after FCB had paid monies to Flexus or made its presentation to the issuing bank.

Key issues

(1) Was the third cargo receipt a compliant document?

The chop in the third cargo receipt was in simplified Chinese characters, while that of the specimen was in traditional Chinese characters.

The issuing bank held the view that this was not a discrepancy, so it did not issue any notice of refusal to FCB. However, the Court of First Instance held that the chop in the third cargo receipt did not conform to the specimen provided by New Era to BOC; consequently, it was discrepant.

The writer agrees with this decision, since the chop forms part of the specimen that must be identical with those shown on the relevant cargo receipts.

(2) Was the issuing bank precluded from rejecting the presented documents due to the absence of a refusal notice?

FCB argued that the issuing bank was precluded from alleging that the third cargo receipt was discrepant, since the issuing bank never served any refusal notice rejecting the third cargo receipt as per sub-article 16 (f ) of UCP 600.

The judge of the Court of First Instance doubted that article 16 was applicable in the manner stated above. The judge therefore held that:

(a) FCB's negotiation of discrepant instead of complying documents jeopardized its right of reimbursement from the issuing bank (see issue 3 below); and

(b) when the issuing bank informed FCB of the injunction, New Era's reasons for contending that the third cargo receipt was non-compliant should have been apparent to FCB by around that time. It should have been obvious to FCB that, if New Era was right, the issuing bank would, in turn, be raising the same grounds for rejecting FCB's tender.

In the writer's view, the judge was obviously wrong, because the injunction would have had no impact on, nor would it lessen the issuing bank's obligation to issue the refusal notice in accordance with sub-article 16 (c). If the issuing bank failed to issue a refusal notice in compliance with sub-article 16 (c), it would be precluded from rejecting the documents once the injunction was lifted.

(3) Was FCB entitled to be reimbursed by the issuing bank?

Court of First Instance decision

The judge of the Court of First Instance said "no" on the grounds that an issuing bank only undertakes to reimburse a nominated bank that has honoured or negotiated a complying pre sentation (sub-article 7 (c)), and negotiation is con- fined to the purchase of drafts and/or documents under a comply ing presentation (article 2).

The judge adopted a literal interpretation of UCP 600. He held that since FCB paid Flexus against the first cargo receipt, which was discrepant, FCB purchased (negotiated) documents under a non-complying presentation. Had FCB presented the documents so obtained (referring to the first cargo receipt with the wrong goods description), the documents would rightly have been rejected as non-complying.

FCB argued that "it could, despite the discrepancy in the first cargo receipt, pay Flexus under the L/C with recourse and then wait until it somehow obtained a full set of compliant documents. It follows that FCB could then present the now complying documents to the issuing bank and claim reimbursement under sub-article 7(c)."

The judge, however, held that to obtain reimbursement under sub-article 7 (c), the documents presented by a nominated bank had to be the complying set of documents which the beneficiary actually presented to the nominated bank and against which the nominated bank actually released payment to the beneficiary. It followed that FCB's presentation was invalid, and the issuing bank had no obligation to reimburse FCB under sub-article 7 (c).

Court of Appeal decision

(a) The issuing bank did not serve any notice of refusal under sub-article 16 (c) and, in fact, the issuing bank did determine that FCB's presentation was compliant.

(b) The judges held that while the defi- nition of negotiation appears to tie the notion of "negotiation" to the notion of "complying presentation", two points should be noted. First, as Professor James E. Byrne1 points out, "there is no necessary relationship" between the two notions. Professor Byrne writes:

"While it may be expected that the documents that are the subject of the negotiation would be complying docu ments, whether or not they comply has no bearing on whether or not there is negotiation. If the issuer or confirmer that undertakes to negotiate [honour] fails to note a dis crepancy, the negotiating bank will still have negotiated. In that situation, the issuer and any confirmer are precluded from asserting the discrepancy and are required to reimburse the nominated bank that has negotiated under the preclusion rule of UCP 600 Article 16 (f ) (Discrepant Documents, Notice and Waiver) even in the event of beneficiary L/C fraud."

The reasoning above is particularly pertinent in that, in the present case, the issuing bank accepted that there had been a complying presentation and, in any event, it was precluded from contending otherwise by reason of sub-article 16 (f ).

The second matter of significance is that no time frame is expressed in the definition of "negotiation". It is clear from article 16 that the "complying presen tation" is viewed from the perspective of the issuing bank at the time the presen tation is made to the issuing bank. The judge made the following comments:

"However, I can discern no reason (much less a valid reason) why, if the missing or discrepant document is subsequently supplied or is made compliant before the negotiation bank actually makes the presentation, the presentation would not be a 'complying presentation'. Logically, a 'complying presentation' has to have the same meaning for articles 7(c) and 16."

The judge further stated that even if her interpretation of UCP 600 were held to be wrong, the express provision of the L/C would become material. The relevant provision stated: "Upon receipt of compliant documents at our counter, we shall accept the relevant presentation and effect payment in accordance with the presenter's instructions." Since the situation envisaged in the express provision had arisen, it entitled FCB to reimbursement.

Another Court of Appeal judge disagreed with the proposition that a negotiating bank was unable to make payment under an L/C until all requisite documents compliant with the terms of that L/C had been presented to it. First, the judge held the view that the precise manner of negotiation of the documents must be a matter for the negotiating bank. Hence, if it wishes to make payment in anticipation (as in the instant case) of the submission of a compliant document in lieu of one that is not compliant, it does so at its own commercial to help the continent's trade risk. Accordingly, if the presented documents are discrepant, there will be no obligation to reimburse. Conversely, if the documents are accepted as compliant, the issuing bank is obligated to reimburse the negotiating bank the payment that it earlier made to the beneficiary.

Otherwise, the issuing bank's reimbursement obligation would depend on not one, but two distinct factors: first, ensuring that the presented documents are compliant and second, ensuring that the payment effected by the nominated the L/Cs, bid bonds and bank bank did not antedate an ultimately compliant presentation. The Court of Appeal, therefore, reversed the lower court's decision and held that the issuing bank was obligated to reimburse FCB.

King-tak FUNG is a Banking Partner of Eversheds Hong Kong, a member of the ICC Consulting Group on the UCP 500 Revision and author of Leading Court Cases on Letters of Credit (www.iccbooks.com) and UCP 600 - Legal Analysis and Case Studies (www.peer.com.hk). s e-mail is ktfung@eversheds.com

1. Professor James E. Byrne, The Comparison of UCP 600 and UCP 500, p. 35.