Article

by N.D. George, CDCS (Distinction)

This refers to the article by Kingtak Fung in the July-September 2012 of DCInsight.

My comments are based entirely on facts as described in Mr Fung's article. Based on the details in the article, the essence of the case is that the second beneficiary was not paid although it presented documents well within the validity of the transferred credit to the transferring bank, which was also the bank where the credit was available. The first beneficiary refused to substitute its invoice, following which the transferring bank decided to exercise its right not to handle the documents at all (the credit did not carry its confirmation), and suggested that the beneficiary present the documents directly to the issuing bank.

Subsequently, the second beneficiary forwarded the documents to the issuing bank, which refused to honour the presentation, although it was received well within the validity of its original credit favouring the first beneficiary. The bank's reason for refusal was based on the terms of the transferred credit, i.e., the presentation was received after the expiry of the transferred credit, and "late presentation" based on the presentation date in the transferred credit.

The issue was referred for a DOCDEX decision, and the DOCDEX experts agreed with the issuing bank's action. A court in Korea did the same. There was an allegation of fraud by the second beneficiary; however, the reasons for refusal, as cited above, were purely technical discrepancies in nature and not based on the issue of fraud. Apparently, the reference to the DOCDEX experts as well as to the court was limited to deciding whether the issuing bank was right in acting the way it did, although its original credit favouring the first beneficiary was still valid when the second beneficiary presented the documents to it.

Questions

The decision of the experts and the court verdicts may be quoted as a precedent in future. Therefore, with due respect for these institutions, I would like to pen my thoughts on the matter with a view to analyzing whether the decision represents best practice, and to reflect on the letter and spirit of the concept of a transferable credit as I perceive it under UCP 600.

In my opinion, the question is: can the issuing bank avail itself of the terms of the transferred credit to refuse documents or must it solely be guided by the terms of its own credit? Or, to put it another way: to what extent can an issuing bank rely on the terms of the transferred credit to decide whether to honour or not a presentation received by it from a transferee?

Analysis

Let me analyze these questions in detail, and for this purposes of this discussion I will consider that there is no fraud involved in the underlying transaction or in the documents submitted.

1. When a transferee beneficiary makes a presentation to a nominated bank, the beneficiary complies with the terms of the transfer. When a complying presentation is made to the nominated bank, the issuing bank is on the hook irrevocably from that moment onwards. The decision of the nominated bank not to act under its nomination is a subsequent event occurring after the transferee's compliance. The transferee has complied by making a presentation within the validity of the credit, and it does not square with any logic, fair play and equity (nor the spirit of the UCP) to demand that it must comply once more by making a timely presentation within the expiry date of the transferred credit to the issuing bank after the decision of the nominated bank not to act on its nomination.

2. Mr Fung's's article makes reference to the UCP provision that a credit available with a nominated bank is also available with the issuing bank. The reference to a credit is apparently to the instrument of transfer. In a commercially sophisticated transferable transaction, the issuing bank is not expected to know the terms of the transfer nor, in most cases, the name of the transferee, let alone the margin involved in the transaction.

A transferable credit is an invention to help middlemen bring buyers and sellers together, keeping them opaque from one another and facilitating the middleman's ability to take its cut and pass on the documents to the issuing bank against its original credit. Such an invention will not work unless a certain commercial discretion and string-pulling is exercised by the first beneficiary vis-à-vis the transferee. The ability to reduce the value, to change the expiry date, shipment dates and the presentation period are some of the examples that fall into this category. These are changes the issuing bank well knows could occur with its credit and over which, having issued a transferable credit, it has no control. In fact, these are not its concern since, whatever the arrangement, the issuing bank knows it's responsible for the value of its original credit and up to its validity date. Hence, not knowing or being privy to the terms of the transferred credit, the issuing bank is required to examine documents on the basis of its own credit and no other. Indeed, this is what happens with issuing banks under transferable credits when they receive documents from nominated banks or any other bank. The decision to honour or not is based purely on the terms of the original credit.

3. A validity date on the transferred credit that is less than the validity of the original credit does not reduce the validity of the original credit, as no amendment as conceived under subarticle 10 (a) of UCP 600 occurs at this stage In fact, UCP sub-article 38 (g) carefully avoids the word "amendment" and merely (and correctly) states: "may be reduced or advanced". Reduction of amounts and advancing the shipment or expiry dates are commercial arbitrage facilities provided to the first beneficiary. As far as the issuing bank is concerned, no terms and conditions of its original credit are amended as a result of the first beneficiary's choosing to avail itself of these facilities.

4. The first beneficiary, having decided not to substitute an invoice, effectively removes itself from the credit. That is why sub-article 38 (i) provides for forwarding the documents as received from the transferee to the issuing bank. And on closer reading, sub-article 38 (i) has another important message to convey: that the first beneficiary cannot frustrate the transferee's right to payment. Not only could it refuse to provide a substituted invoice, it could also create other discrepancies. The correct interpretation of sub-article 38 (i) in my view is that the nominated bank is expected to respect the transferee's right to payment and not frustrate it. I believe the first beneficiary in the case cited above was able to frustrate the transferee's right to payment because it found an obliging nominated bank to cooperate. If this bank had refused to cooperate and instead had forwarded the documents without any further responsibility to the first beneficiary as provided under sub-article 38 (i), this attempt would not have succeeded.

5. In the case in question, the nominated bank apparently contacted the first beneficiary to discuss the substitution of the invoice. This raises the question: why did it make this contact if it had no intention of acting on its nomination? Mr Fung's article does not throw any light on this subject. The nominated bank's decision to refuse to handle the documents was apparently an afterthought consequent to the action of the first beneficiary, i.e., its refusal to substitute an invoice and instead to allege fraud by the second beneficiary. Moreover, a second question arises: how many days were lost at the nominated bank from the time it received the documents to its decision to return them to the second beneficiary? Mr Fung's article does not say. In any event, it's easy to see in this case that the transferee beneficiary's right to payment can be frustrated by the original beneficiary if it can find a cooperating nominated bank. This is not what is intended under the UCP.

Best practice

Having noted the above, what should be the best practice to be followed in a situation similar (but with no allegation of fraud) to the one discussed in Mr Fung's article? Fraud is a different animal which has to be dealt with legally and not by sacrificing the letter and spirit of UCP.

In my view, a nominated bank that refuses to act under its nomination after receipt in a timely manner of documents from the transferee should put the issuing bank on notice of its action. This would make the issuing bank aware that a presentation as conceived under article 7 of UCP 600 has occurred and that, as a consequence, it is on the hook. Whether the nominated bank honours or negotiates is immaterial for a presentation to become a valid one. (Negotiation or honour does not add to or detract from the historical fact of the receipt of a complying presentation, but only results in a change of ownership of the payment obligation of the issuing bank, i.e., instead of the transferee, the ownership moves to the nominated bank.)

When the documents are received subsequently from the transferee, either directly or through another bank, the issuing bank must do a certain minimum due diligence (just as it does under a normal credit when a beneficiary bypasses the nominated bank) by contacting the nominated bank to ascertain the name of the transferee, the amount transferred, the details of payments to be made to the first beneficiary, if any, the balance available under the credit and outstanding bank charges.

N.D. George, after more than four decades in banking in India, UAE and Bahrain, retired to his native city Kochi in India. His mail is cochin1949@gmail.com