Documentary Credit World

(For Part 1 of this Executive Summary covering discussions taking place on Day 1 of the 2023 Americas Annual Survey, see June 2023 DCW 25.)

If I Had a Nickel for Every Fraud ... I Would Still Need to Launder It

In this session to open Day 2 of the Survey, panelists emphasized that little has changed as regards to contemporary frauds such as Trafigura’s USD 577 million loss from bogus nickel shipments and Balli Steel’s USD500m fictitious trading dealings compared to the oft-cited Solo Industries debacle and other fraudulent schemes of the past. Although technology is helping to expose illicit activity, frauds are still occurring, particularly when trading markets tighten up.

Following issuance of additional guidance relating to Russia sanctions, more is being expected of banks. Panelists referenced a US FinCEN Alert urging continued vigilance among financial institutions against attempts to evade US export controls directed at Russia. Of note, financial institutions are urged to conduct due diligence including evaluation of when a company was incorporated. Although not an explicit requirement, many banks are treating the Alert as mandatory and implementing procedures accordingly.

Panelists also addressed the Singapore case, Kuvera Resources v. JPMorgan Chase Bank, in which an LC beneficiary sued a confirming bank that returned complying documents citing the sanctions clause included in its confirmation. The beneficiary claimed that the clause was a non-documentary condition, but the judge disagreed and the clause in any event was unrelated to what documents the beneficiary was required to present. The beneficiary also contended that the confirmer, as a Singapore branch of a US bank, was a distinct legal entity from its US parent and therefore not subject to US sanctions law. The judge rejected this argument as well, noting the beneficiary’s misunderstanding of UCP600 Article 3’s provision regarding bank branches. (For a detailed case summary, see Nov/Dec  2022 DCW at 18.)

Other comments expressed during the discussion were critical of regulators and their expectations of banks operating in the trade finance space. One commenter opined that regulators are ill-prepared to handle the amount of information they receive from banks. Consequently, the banking industry should “push back” on unduly onerous requirements imposed by regulators. Additionally, the view was expressed that regulators committed to curbing financial crimes need to allow greater information sharing among financial institutions. The open account area is largely unregulated which presents another imposing challenge.

The Swift Report

Mukta Kadam of Swift then delivered an update on development of the next Swift Standards Release that will go live in November (SR 2023) and new initiatives. For Category 7 messages, the major transformations were in November 2018 (for LCs) and in November 2021 (for guarantees and standbys). Changes for SR 2023 include treatment of supplementary information about amount in Field 39F and a new field to handle requests for new date of expiry of a local undertaking, Field 31R. Especially important for corporates initiating communication, MT 798 Trade Guidelines were upgraded to adjust for Cat 7 changes and will also take effect in November 2023. Swift is presently seeking pilot participants, especially corporates, for its work on bank guarantee APIs and has submitted a business justification to have these APIs registered with ISO 20022. Kadam’s 2023 Swift Update presentation slides are available on the IIBLP website.

More  from  the  Courts

Additional cases worthy of attention were addressed by panelists on Day 2 of the Annual Survey.

Documentary Collection Case

The first case discussed by the panel, Select Harvest USA LLC v. Indian Overseas Bank, involved a documentary collection, the URC and jurisdictional matters. The case is a tutorial for documentary collections under the URC and international trade practices (case addressed in detail in June DCW at p. 6).

Credit for LC Draw Proceeds Case

For purposes of rejecting a claim for prejudgment attachment for holdover rent in California, a court determined that an LC is not a security interest in the debtor ’s property even though the LC’s reimbursement is secured. This was the key question raised in Rreef America Reit II Corp. v. SamsaraInc. (Case No. A163827 (Cal. App. May 15, 2023)). Under California’s statute providing for prejudgment attachment for real estate lease claims, the claim is to be reduced by the amount of security the landlord holds for in the lessee’s property for obligations under the lease. The court determined that even though the landlord held as beneficiary a USD 11.3 million LC posted by an industrial tenant as security under its lease, that did not defeat the landlord’s prejudgment issuance of writ of attachment for unlawful detainer action against the tenant for USD 3.8 million in rent and other costs. Citing well recognized LC authorities that the proceeds of an LC draw are not property of the applicant but of the issuing bank, the court upheld the prejudgment attachment claim; under a strict interpretation of the wording of the statute, it only allowed reduction of the attachment amount claimed based on a security interest in the tenant’s property, not in the property of the bank.

LC Obligation Runs with the Land for Municipal Improvements Case

In The Village of Kirkland v. Kirkland Properties Holdings Co., 2023 IL 128612 (May 18, 2023)), the Illinois Supreme Court decided that the duty to post an LC under an annexation agreement can run with the land annexed even if the land is subdivided, so that a subsequent developer and purchaser of a portion of the land is obligated to post an LC to secure municipal improvement obligations pro rated based on the amount of land purchased.

LCs as Adequate Assurance of Performance Case

In Skyview Finance Company v. Kearsarge Trading (C.A. No. 20-11666-PBS (D. Mass. Jan. 13, 2023)), the court determined that, a demand that a counterparty post an LC for the full notional amount of energy credit trades was not justified under the terms of the contract, nature of the trades, and circumstances of the parties and therefore demanding that an LC be posted for the full notional amount and threatening termination of the trading contract for energy credits constituted anticipatory repudiation of the contract. As it turned out, the party demanding additional LC security was the party out of the money. A panelist commented that in many cases where collateral is required to secure trades of commodities, securities, or financial instruments, it is frequently the out- of-the-money position of the trader that needs to be secured, and not the entire notional amount of the trade, because that amount is the loss the counterparty faces as damages if the trade is not completed by the counterparty required to post collateral.

Issuer Insolvency Case

Although not an LC case, The Wall Guy, Inc. v. FDIC as Receiver for The First State Bank (C.A. No. 3:20-0304, Consolidated with 3:20-0305 (S.D.W.Va. Feb. 7, 2023) addresses FDIC powers when dealing with failed banks. The court determined that in order to sell a failed bank’s property as part of its orderly liquidation and based on the wording of the parties’ agreement, the FDIC could remove the mortgage lien on a failed bank’s property which secured a stay pending appeal of an adverse judgment against the failed bank in exchange for an LC posted by the FDIC.

Chinese Sanctions Case

Saibo Jin reported on a Chinese case involving sanctions and force majeure. Chinese ships going into North Korean waters to fish enjoyed lucrative business until the imposition of UN sanctions halted their operations. A Chinese court said that the impact of UN sanctions constituted a force majeure event and that the party had an excuse for its non-performance. Overall, Jin said there have been at least 20 cases in China involving sanctions matters.

Right to Require Large LC to Secure Indemnity Obligations Case

While it is difficult to enjoin a draw on an LC, it may also be difficult to enjoin a demand to post an LC to secure a bond issued for environmental clean-up obligations. In MLCJR, LLC v. PDP Group, Inc. (2022 NY Slip Op 34345(U)(N.Y.S.Ct. Dec. 19, 2022)), the court denied a motion to enjoin a demand by sureties demanding a USD 100 million LC to secure potential environmental indemnity claims for extraction of offshore oil and gas in the Gulf of Mexico.

LC Lease Security Case

In Majestic Rayon Corp. v. Soho Office Suites, LLC (2023 NY Slip Op 31025(U) (N.Y.S.Ct. March 30, 2023)), after a landlord drew down USD 450,000 on an LC posted as security and its tenant failed to “replenish” the LC, the tenant was in breach of its lease, and the landlord had right to terminate the lease, notwithstanding tenant’s claim of frustration of commercial purpose due to the pandemic. It was noted that in New York, very few if any lessees have had success in enjoining or recovering draws under LCs supporting the lessees’ obligations under commercial leases.

Supersedeas LC Case

In Glacier Bear Retreat, LLC v. Matt and Rachel Dusek, No. CV 22-19-M-KLD (D. Mont. Feb. 17, 2023), the court determined that a stay of execution post-judgment trial can be extended while the defendant procures an LC to act as supersedeas. Panelists noted that there is a short time, usually 30 days under amended FRCP 62, to post supersedeas security in the form of LC security or a bond after a judgment has been entered and became final. (Case summary at 18.)

Declaratory Judgment of Right to Draw

Although it is difficult to enjoin a draw on an LC if there is a colorable basis for it, an insurance or surety company may want the assurance of a court order that it is acting properly in drawing on an LC supporting its insured’s indemnity obligations under bonds or insurance contracts. By doing so, the insurer prevents later arguments made against it by its insured of bad faith, breach of contract and other claims. That was the case in Liberty Mutual Fire Insurance Co. v. The Shaw Group, Inc. (C.A. No. 3:20-CV-871-JWD-RLB (M.D. La. March 15, 2023). There an insurance company LC beneficiary asked for and received a court to order authorizing it to draw on the LC for indemnification of deductible amounts it claims the insured owes it.

Managing Vessel & Shipping Risk

In April 2023, S&P Global Market Intelligence, IIBLP, and Global Financial Integrity collaborated to release “Vessel Ownership, Trade Finance and Regulatory Compliance”. The freely available 12- page paper examines vessel risk from the lens of whether group ownership information is known or unknown for each vessel alongside identified compliance behavior. The paper then offers recommendations for financial institutions regarding their risk and compliance screening programs as well as policy proposals for regulators to consider.

A panel discussion led by IIBLP CEO Michael Byrne touched on the paper ’s background and key findings. Granted to do so by the United Nations, S&P Global Market Intelligence issues International Maritime Organization (IMO) numbers to vessels. One of the fields to obtain an IMO number is optional is ownership and the absence of that data poses challenges. In the paper ’s review of more than 68,000 vessels, over 8,000 vessels (12.2%) had unknown owner information. Of these vessels with unknown ownership, just 2,571 vessels attained “Compliant” regulatory status, while 4,445 vessels of were assessed a “Warning” compliance score and another 1,321 vessels received a “Severe” compliance score. (To be “Compliant” means that a vessel has met all regulatory requirements in regard to the latest maritime advisories published by OFAC and OFSI and also has not otherwise engaged in risky behavior that would designate it with a “Warning” or “Severe” status.)

Based on this yellow/red light system, panelists underscored the paper ’s top recommendation that vessel ownership listings be treated as a risk assessment tool. Since nearly 70% of vessels with unknown owners carry either a Warning or Severe compliance designation, financial institutions should consider vessel ownership as a primary risk indicator and conduct further due diligence on vessels without known owners. The panel also referenced the paper ’s study of flags of convenience which may shed further light on risk factors of vessels with an unknown owner listing.

Confirmations: The Good, the Bad, and the Ugly

In taking up discussion of this important aspect of LC practice, the panel first considered the use and purpose of confirmations: Dealing with the unknown credit strength or LC reputation of a foreign issuer, avoiding issues of cross border political or economic instability; use of local jurisdiction for governing law; using a local bank for presentation of documents; and possibly for avoiding the effect of foreign laws and court orders affect the rights to draw. Among their Annual Survey conference materials, delegates were provided a past article by Michael Evan Avidon presenting several weighty considerations emerging from the multi-layered question: “Riskier Than You Think: May a Confirmer (i) Vary or Deviate From Terms and Conditions of a Letter of Credit It is Requested to Confirm or (ii) Qualify or Limit its Confirmation?”

The panel revisited the recent Celestial Aviation and Lummus Technology decisions and also referenced a seminal past case, Banco de Vizcaya v. First Nat. Bank of Chicago, 514 F. Supp. 1280 (N.D. Ill. 1981), which considered whether FNBC was a confirming bank and also the role of a reimbursing bank.

Confirmations are separate undertakings and banks contemplating the role of confirmer need to consider what they are seeking to accomplish. An interactive and spirited discussion ensued among panelists and attendees regarding how a bank can: qualify its confirmation as regards when it will pay; exclude an automatic extension clause; insert a sanctions clause; and consider governing law and jurisdiction clauses before it adds its confirmation.

Digital Trade & the Future of Trade Finance

When considering the constant evolution of technology and its transformative impact on banking processes, assessing this ever-changing landscape can be mindboggling for specialists. Panelists and attendees identified staunch challenges such as the complexities of extracting data from documents and adapting screening mechanisms to account for geo-political risks. Other commenters expressed optimism that professionals leverage what resources are currently available to advance the industry and today’s experienced specialists teach and explain their craft to help the next generation become tomorrow’s leaders. Although it is difficult to predict what tools and technology will prove effective in the future, talented professionals will adapt and figure it out. The importance of building and maintaining strong customer relationships is vital as well and cannot be completely subsumed into technological processes. Artificial intelligence and systems will greatly enhance the trade finance field, but decision-making authority will still reside with humans.

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