Documentary Credit World

Confirmation to any modern-day documentary credit is an essential risk mitigation tool for a beneficiary that enables it to deal with its customer across the globe. Adding confirmation to a credit enables a beneficiary to mitigate country risk and bank risk of the issuing bank. When a credit is confirmed by a bank preferable or acceptable to a beneficiary, usually in a different country, this confirmation provides the beneficiary a definite undertaking from the confirming bank, in addition to that of issuing bank, to get payment for a complying presentation. This undertaking is autonomous from the confirming bank’s ability to attain reimbursement from the issuing bank. This independence stands even if the issuing bank becomes insolvent and/or the country turns into a default state

To maintain autonomy between the undertaking of the issuing bank and confirming bank, UCP600 contains two separate rules (Article 7 and 8) in addition to its Article 2 definitions of the term ‘Confirming Bank’ and the concept of ‘Confirmation’.

To further explain the concept, let us take an example:

Bank IB of country X issued a credit denominated in USD, in favour of beneficiary B. The credit is confirmed by Bank CB of country Y (in Europe). Soon after adding confirmation to the credit, Bank IB went into liquidation. Beneficiary B makes a complying presentation to Bank CB. Bank CB must honour or negotiate the presentation without considering the prospects of it getting reimbursed from Bank IB.

What if country X defaults, in addition to the insolvency of the bank IB, or the applicant secures a temporary injunction on the issuing bank, preventing it from making payment? The short answer is that the confirming bank is still obligated to honour, negotiate, or reimburse a complying presentation. This obligation remains in place because the confirming bank’s undertaking is independent from the issuing bank’s undertaking under a credit. When honouring its obligation, a confirming bank utilizes its own “pocket”; not the “pocket” of the issuing bank.

What if Bank IB is sanctioned by the US’ Office of Foreign Assets Control (OFAC) or the Council of the European Union imposes restrictive measures on it? For a European confirming bank, restrictive measures imposed by the Council of the European Union are considered mandatory law and the sanctions assessed by OFAC are indirectly mandatory law due to settlement in USD [not considering the complexity of Article 5 of the EU Blocking Regulation]. In such case, should the confirming bank honour or negotiate a complying presentation?

ICC Banking Commission Opinion TA752rev3 (2012) addressed a similar issue. The query involved a bank in country L that issued an LC on 8 October 2010 and a Western European bank that added its confirmation of the LC the same day. The beneficiary made a complying presentation to the confirming bank on 17 March 2011. Four days later, the Council of the European Union added the issuing bank to its list of persons and entities subject to restrictive measures under the relevant Council Regulation (the Sanction List). Article 5 of the Council Regulation applies certain sanctions to those on its Sanction List, namely:

• freezing their funds;
• prohibiting the making available of funds for their benefit;
• explicitly allowing financial institutions in the European Union to credit frozen accounts, pay interest on those accounts, and make payments to those accounts under obligations which arose before the date on which the person or entity was included on the Sanction List.

On 3 May 2011, the confirming bank informed the beneficiary that because the issuing bank was subject to EU sanctions, the confirming bank did not feel obligated to effect payment under its confirmation of the credit.

One of the questions posed to the ICC Banking Commission: “Does the mere fact that the issuing bank was added to the EU Sanction List after presentation of the documents excuse the confirming bank from its obligations under UCP 600 sub-article 15 (b) and article 8?”

In its analysis, the Banking Commission reminded that the confirming bank must abide by the mandatory laws applicable to it which “override the UCP and any undertaking contractually issued by that issuing or confirming bank.” It further added: “Directly applicable economic sanction laws are generally considered as being mandatory. … Any disputes on application of the particular sanctions by the confirming bank or its relevant activity should be submitted to the competent court.”

Based on this premise, the Banking Commission concluded that: “A confirming bank may decline to honour or negotiate under its undertaking when economic sanctions that are applicable to it by law or regulation specifically prohibit it from doing so.”

Technically speaking, the above analysis has not given due importance to the independence of the confirming bank’s undertaking from that of the issuing bank.

Given due importance to the independent confirming bank’s undertaking, the analysis part of this opinion could be structured as:

When a nominated confirming bank has added its confirmation to the credit, its undertaking to honour a complying presentation is independent of any other undertaking to the beneficiary, including the issuing bank undertaking.

Directly applicable economic sanction laws are generally considered as being mandatory. Therefore, the confirming bank must abide by mandatory law that prohibits it from honouring a complying presentation.

However, generally speaking, even when the issuing bank is listed under restricted measures by the Council of the EU, the confirming bank should not be prohibited from honouring its own obligation separate from the issuing bank. If this is the case, the confirming bank’s honouring a complying presentation should not be considered a breach of mandatory law due to the principle of autonomy.

Conversely, should the related restrictive measures prohibit the confirming bank from honouring its obligation, the confirming bank must abstain from fulfilling its obligation arising from the UCP as mandatory applicable law prevails over UCP or any other practice rules. Any disputes on applying the particular sanctions by the confirming bank or its relevant activity should be submitted to the competent court.

Following the above analysis, the opinion may conclude that the confirming bank must honour a complying presentation of the beneficiary subject to compliance with the mandatory law.

Recently, the English court dealt with a similar scenario in Celestial Aviation Services Ltd v UniCredit Bank AG (London Branch).₁ From 2017 to 2020, Russian financial institution, Sberbank (Issuer) issued seven standby LCs in favour of Irish aircraft lessor, Celestial Aviation Services Ltd. (Celestial- Beneficiaries) to secure lease obligations of two Russian civilian aircraft companies (Applicants). To secure another separate aircraft lease obligation of one of the Russian aircraft companies, Issuer issued another five standbys in favour of Constitution Aircraft Leasing (Ireland) 3 & 5 Ltd. (Constitution-Beneficiaries). UniCredit Bank, London Branch (Confirming Bank) confirmed all of the standbys which were issued in USD.

After the Russian invasion of Ukraine in February 2022, various sanctions were imposed against Russia by the EU, UK, and US. Therefore, the underlying agreements were terminated. Both beneficiaries of the various standbys demanded from the confirming bank beginning in March 2022.

The confirming bank received demands for nearly USD 70 million across the 12 standbys but refused to pay otherwise complying presentations due to the UK, EU and US sanctions. The beneficiaries sued the confirming bank.

The pertinent regulations are the Russian sanctions imposed by the UK (specifically, Regulations 11, 13, and 28 of the Russia (Sanctions) (EU Exit) Regulations 2019 No. 855).

In the intervening period between the beneficiaries’ demands and the hearing, the confirming bank obtained licenses from UK and EU regulatory authorities and settled principle amounts of all standbys. However, the parties remained in dispute on matters regarding costs and interest.

The UK High Court dealt with the case on Regulations 11, 13, and 28 separately:

• Regulation 28 (provision of financing for the supply of restricted goods/technology)
  The Court confirmed that the purpose of this Regulation is “to ensure that financial assistance was not provided to Russian parties in relation to, inter alia, the supply of aircraft”. The Court regarded the autonomy principle as important and stated that the confirming bank’s obligation to the beneficiaries under the standby is wholly independent of any other transaction elements. The beneficiaries are the only parties benefitting from payment. While the confirming bank’s payment to the beneficiaries would have the collateral result of discharging the independent obligations of the Russian lessees and Russian issuing bank towards the beneficiaries, the issuing bank would remain liable to the confirming bank and the Russian lessees would remain liable to the Russian bank. Accordingly, neither the Russian lessees nor Russian bank would benefit from the confirming bank’s payments under the standbys. Therefore, the court concluded that the confirming bank was not relieved of its obligation to make payment under Regulation 28.
• Regulation 11 (dealing with funds or economic resources owned, held or controlled by a designated person)
  The confirming bank argued that paying the beneficiaries would amount to “dealing with funds… owned, held or controlled by the Russian issuing bank. The Court dispelled the argument and said that “[the confirming bank] was not dealing with [the Russian issuing bank’s] property when making payment” to the beneficiaries under the standbys because “[the confirming bank] was instead satisfying its own independent contractual obligations. [The Russian issuing bank’s] property was not in any way interfered with”.
• Regulation 13 (making funds available to any person for the benefit of a designated person)
  The confirming bank’s payment to the beneficiaries would not discharge the Russian issuing bank’s obligations under the standbys. The Russian issuing bank would remain under an equal obligation to reimburse the confirming bank.

It is clear from the above court ruling that the UK High Court has given paramount importance to the autonomy principle of the standby letters of credit, even when dealing with sanctions issues.

Although ICC Opinions are non-binding, they do provide guidance for how the UCP should be applied in a number of given situations. Moreover, ICC Opinions have been referenced as evidence in court cases from time to time to support the position of a plaintiff or defendant. Could the ICC Banking Commission’s stated Opinion have better highlighted the autonomy of a confirming bank’s undertaking from the issuing bank’s undertaking? In this instance, did the court accurately distinguish the independence of these undertakings?

* A.T.M. Nesarul Hoque is Senior Vice President at Mutual Trust Bank Limited in Dhaka, Bangladesh. He is a working group member of ISBP 821E, member of ICC DOCDEX, DCW Editorial Advisory Board member, and co- author of the book “The Banker ’s Guide to Examination Under Documentary Credits”. Mr. Hoque has written extensively on matters pertaining to LC practice and the UCP rules. He may be contacted at: nesarulh@gmail.com

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