Article

by King-tak Fung

This writer wrote an article for DCInsight on silent confirmation under UCP 5001. With more and more recent court cases involving silent confirmation, it would be prudent to revisit this topic under UCP 600.

Many corporations adopt a policy that all export letters of credit received must be confirmed by their banker(s) in order to cover the payment and country risks of the L/C issuing banks. However, some L/C issuing banks do not like their L/Cs to be confirmed, because they regard such an action as having a potentially negative impact on their credit standing. Consequently, in order to meet market demand, banks may provide a service called "silent confirmation". Some banks call this "payment guarantee", "commitment to negotiate" or "commitment to purchase"; each essentially refers to similar "without recourse" financing arrangements between the silent confirmer and the beneficiary.

What is silent confirmation?

The exporter's bank incurs a definite payment undertaking in addition to that of the L/C issuing bank without the instructions/authorizations of the issuing bank. Accordingly, it undertakes to the exporter that it will honour the exporter's drawing(s), either by way of making immediate payment or undertaking an obligation to make payment on a without recourse basis provided that compliant documents are presented.

Risks

The major exposure of the silent confirmer is that it can neither claim on the beneficiary (because the financing is on a "without recourse" basis) nor the issuing bank, as it might have no locus standi (i.e., not be in a position) to sue the issuing bank in its own name if the issuing bank defaults, because it has never been authorized by the issuing bank to confirm the L/C. This issue has deterred a number of banks from entering into the silent confirmation business.

New position under UCP 600?

In the leading case Banco Santander S.A. v Banque Paribas2, the English courts held that neither a deferred payment undertaking bank nor a confirming bank is authorized by the issuing bank to prepay or finance the beneficiary before maturity under UCP 500.

During the revision process of UCP 500, a number of countries were of the view that an L/C, in addition to its payment function, should also be a financing instrument. To address the decision in the Banco Santander case, sub-article 12 (b) of UCP 600 states: "By nominating a bank to accept a draft or incur a deferred payment undertaking, an issuing bank authorizes that nominated bank to prepay or purchase a draft accepted or a deferred payment undertaking incurred by that nominated bank."

With the new sub-article 12 (b) and sub-article 7 (c), it has become clear that a nominated bank is entitled to be reimbursed by the issuing bank provided the presentation is complying. It follows that under English, Hong Kong or Chinese law, a nominated bank may also be immune from the fraud exception provided it acts in good faith, for value and without notice of fraud, at the time it negotiates the presented documents, prepays a deferred payment undertaking incurred by it or purchases a draft accepted by it.

It is not uncommon for a bank to perform different roles in an L/C transaction, e.g., the advising bank may also be a nominated bank (defined in article 2 of UCP 600) which is authorized to pay, to incur a deferred payment undertaking, to accept draft(s) or to negotiate. By acting as a nominated bank, it is entitled to be reimbursed by the issuing bank under sub-article 7 (c) of UCP 600.

Accordingly, silent confirmation is probably workable, because the relevant arrangements, as discussed above, are separate from and independent of the L/C contract. In addition, the payment obligation of the issuing bank depends on the compliance of documents presented, not the status of the presenter. This view is supported by DOCDEX Decision No. 297 - item (3) which states: "The silent confirmation/ without recourse arrangements entered into between the Nominated Bank and the beneficiaries were arrangements made outside of the terms of the credit, and they do not affect or change in any way the Issuing Bank's reimbursement obligation to the Nominated Bank which has negotiated the credit."

Mitigating the risk?

There are four key points to be made here:

a. The financing must be provided by the nominated bank, i.e., the bank with which the L/C is available by negotiation, acceptance or deferred payment. Any bank is deemed to be a nominated bank if the L/C is available with any bank.

b. It is advisable for the nominated bank to inform the issuing bank in its cover letter that it has (i) negotiated the presented documents, or (ii) prepaid or incurred a deferred payment undertaking, or (iii) purchased a draft accepted by it under the L/C. This is to secure its right of reimbursement under the L/C by advising the issuing bank that it has accepted the nomination and has provided financing against the presented documents in accordance with article 2 or sub-article 12 (b).

c. It would be ideal if the nominated bank were to also advise the beneficiary in writing that its payment to the beneficiary is a negotiation of the presented documents and/or draft(s), or a prepayment of a deferred payment undertaking incurred by it or a purchase of a draft accepted by it under the L/C. These steps are aimed at eliminating the potential argument from the issuing bank that the financing was only a loan granted by the nominated bank to the beneficiary instead of an act authorized by the issuing bank under the L/C.

d. As "silent confirmation" is not covered by the UCP, it is not advisable to use this term in the relevant documentation between the beneficiary and the nominated bank. The use of a title such as "Master L/C Financing Agreement" or the like would probably serve the purpose and avoid unnecessary ambiguity. In short, in using this or a similar procedure, the financing bank can claim reimbursement from the issuing bank in the capacity of a nominated bank under sub-article 7 (c), and not as a silent confirmer.

More secure?

Sub-article 10 (d) of UCP 500 expressly stated that the issuing bank is obligated to reimburse the nominated bank and/or confirming bank if compliant documents are presented. However, sub-article 7 (c) of UCP 600 only covers the nominated bank but not the confirming bank: "An issuing bank undertakes to reimburse a nominated bank that has honoured or negotiated a complying presentation and forwarded the documents to the issuing bank."

Sub-article 8 (c) of UCP 600 states: "A confirming bank undertakes to reimburse another nominated bank that has honoured or negotiated a complying presentation and forwarded the documents to the confirming bank."

Arguably, an issuing bank is obligated to reimburse the confirming bank if the confirming bank is also considered to be a nominated bank. Nevertheless, pursuant to the definition in article 2, a "nominated bank" is defined as "the bank with which the credit is available or any bank in the case of a credit available with any bank". If an L/C is available with Bank A by negotiation and is confirmed by Bank B, strictly speaking Bank B does not fall within the definition of a nominated bank and, as such, the L/C is not available with Bank B.

Nonetheless, the spirit of the UCP is that an issuing bank is obligated to reimburse any party duly authorized by it to incur a payment undertaking or to effect payment under an L/C. To avoid doubt, the prudent practice is to ask the issuing bank to state in writing that the confirming bank will be reimbursed as if it were a nominated bank whenever the L/C is not available with the confirming bank but with another bank.

Silent confirmation agreement

To minimize the silent confirmer's exposure, it is advisable to have the beneficiary execute an agreement detailing the rights and obligations of both parties, in particular the exact types of risk that the silent confirmer has agreed to take or exclude. There are two main approaches adopted by banks in the market, namely (i) to spell out all the risks covered by the silent confirmer but not further or otherwise, or (ii) to state that any financing provided by the silent confirmer is without recourse subject to certain exceptions set out in the agreement.

Some banks will provide a silent confirmation service based on agreements drafted under the UCP 500 regime despite the fact that the L/Cs are all generally subject to UCP 600. This could be very risky, since the relevant terms and arrangements (e.g., payment to be made xxx days after the latest reimbursement date) may jeopardize the position of the financing bank as a negotiating bank. Article 2 of UCP 600 expressly states that advancing or agreeing to advance funds to the beneficiary is to be performed on or before the banking day on which reimbursement is due to the nominated bank.

Conclusion

With the increasing demands for this type of service, it appears that the rationale for not authorizing other banks to confirm one's L/C because of an issue of "face" is rather weak. First, if the beneficiary has concerns with respect to the issuing bank's credit standing, it will obtain a silent confirmation from its banker notwithstanding the fact that the issuing bank has not expressly authorized such an action. More importantly, the beneficiary may mainly be concerned with the risks of the country where the issuing bank's branch or headquarters is located - such as imposition of foreign exchange controls, political instability, etc. - as opposed to the credit standing of the issuing bank. Banks frequently confirm L/Cs issued by their own branches if they are situated in a high-risk country.

It may well be an appropriate time for banks to reconsider their policy of not authorizing other banks to confirm their L/Cs. l

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

1.Documentary Credits Insight,Volume 7 No 1. Winter 2001.

2. [2000] Lloyd's Rep Bank 165 (England).