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For the 17th consecutive year, the Institute of International Banking Law & Practice conducted its one-day Americas Standby & Guarantee Forum. This Executive Summary provides an overview of topics discussed and debated by leading professionals at this year’s event hosted by Hogan Lovells in New York and held as a hybrid event.
News & Trends in Treasury & Working Capital
Changes are likely coming to the US regulatory capital rule, including risk-weighting treatment for letters of credit, but only for large banking organizations in the US. In July 2023, the US Federal Deposit Insurance Corporation (FDIC) with other US regulatory bodies jointly issued a Notice of Proposed Rulemaking that would revise the measurement of risk-weighted assets and the definition of regulatory capital applicable to banking organizations with assets of more than USD 100 billion. If adopted as proposed, the amendments to the regulatory capital rule – patterned after the Basel III capital adequacy framework – would significantly increase the fees impacted banks would have to charge for standby letters of credit. Consequently, banks below the USD 100 billion asset threshold could have an LC pricing advantage. Additionally, the proposed rule, which would be fully phased in on 1 July 2028, has no grandfather period. Comments on the proposal may be made through 30 November 2023. One panelist informed that BAFT is preparing to file a comment, seeking to obtain a carve out exception for LCs.
ISP98 entered into force on 1 January 1999. Reflecting on ISP98 at 25 years, panelists affirmed that the rules have served the standby LC industry exceptionally well and “withstood the test of time”, while also noting there has been no groundswell of support for revision of the rules. One commenter remarked that one possible area to revisit would be an operational aspect of the ISP98 Rule 5.03 preclusion rule. The rule is clear that if documents are presented and retained by the issuer or confirmer, failure to give timely notice of a discrepancy in any retained document precludes assertion of such discrepancy in such retained document. But what if some or all of the documents are returned to the presenter and then purportedly represented, or what if on representation the presenter does not state whether some or all of the documents are being represented (as opposed to being new documents or cured documents)? The rule states that failure to give timely notice of a discrepancy in a represented document precludes assertion of such discrepancy in such represented document. How is an issuer or confirmer supposed to know that a document has been represented to it, and how is it supposed to know whether the represented document has been altered since it was originally presented? Is the rule based on a presumption that an issuer or confirmer would know whether a document was previously presented to it? How would an issuer or confirmer determine that after it returns a document to the presenter? The issuer or confirmer cannot make such determination from its own books and records. Is it entitled to rely upon a statement from the presenter that the document is the same document presented before? Or is the fact whether or not the document is the same as one previously returned in the nature of a non-documentary term or condition that ought to be disregarded?
Formulated two years ago, the International Standard Demand Guarantee Practice (ISDGP) is a best practices guide intended as a companion document to URDG758. It was pointed out that most problems with demand guarantees occur at the drafting phase and ISDGP has greatly assisted practitioners using it. Other panelists commented that they would like to see more use of guarantees in the US. Although US banks are clearly permitted to issue guarantees, few do so.
Insights were then offered on use of standbys and guarantees in Latin America (LATAM). Globalization and economic growth in LATAM over the past decade has led to LATAM banks receiving more standby and demand guarantees than ever from their correspondent banks worldwide. Some 85% of infrastructure and other investment projects are backed by issuance of counter guarantees in favor of local guarantors to support issuance of local guarantees. Domestic demand guarantees and standbys are also issued by local guarantors in favor of third parties. According to one informal estimate of prevailing trends for guaranteeing performance of investment projects in Latin America, counter guarantees subject to URDG outpace counter standbys subject to ISP98 by a 6-to-4 ratio.
In the case of Mexico, anecdotal evidence suggests that US banks and financial institutions in Mexico are much more likely (85%) to issue standbys than demand guarantees. In Bolivia, the vast majority (95%) of counter instruments received are subject to ISP98 but when local undertakings are issued, they are demand guarantees because Bolivian law so requires and the local guarantor must honor payment demands within 24 hours. Overall, banks in LATAM are more comfortable issuing standbys than demand guarantees. Beneficiaries usually require confirmation and, as a result, favor standbys. Under demand guarantees, the guarantor must give notice to the applicant that the beneficiary has presented its demand payment before honoring the guarantee, so this is another reason why standbys are preferred.
The panel then turned to bank closings and how they impact the place for presentation. If a standby is issued subject to ISP98, then it is not a problem as Rule 3.14(b) allows the issuer to send notice to the beneficiary, designating a reasonable alternative place for presentation. For a UCP standby, the issuer would need to amend the standby and hope the beneficiary would consent to such. One panelist remarked about an obstinate US state government department routinely unwilling to have the place for presentation changed.
Panelists then considered the matter of backdating standbys. If a “good customer” asks their banker to backdate an LC, should a banker do so? The consensus view is that it should not be done. In some instances, a clause could be added to the effect that “This letter of credit covers obligations outstanding as of [date].” Insurance companies, in particular, have been known to accept such. One conference delegate said that if a customer insists on backdating, a banker could respond by asking that they obtain a letter from the regulator who apparently needs the LC backdated. The customer would not be able to secure such letter. Others underscored that regulators and auditors do not allow for backdating. One banker admitted that they have backdated a standby, with applicant, beneficiary and their bank knowing, but typically not over a previous month’s period. Other attendees acknowledged that their internal systems do not allow for issuance of backdated credits.
Standby & Guarantee Cases
Panelists addressed select court decisions of noteworthy recent cases involving independent undertakings.
In the UK case, Celestial Aviation v. UniCredit Bank, Irish aircraft lessors (Beneficiaries) sued a German bank’s London branch (Confirming Bank) that alleged sanctions prohibited it from honouring complying demands on standbys subject to UK law and payable in US dollars. The standbys were issued by a Russian bank in 2017 and 2020 on behalf of Russian lessees for underlying transactions prior to 2017. After refusing to honor, Confirming Bank applied to offices in three jurisdictions (UK, EU, US) for licenses to pay. Beneficiaries maintained that the bank’s payment obligation was independent of the underlying transaction while the Confirming Bank argued that applicable sanctions prevented it from paying. The Confirming Bank’s arguments did not sway the court which said that sanctions operate prospectively, not retrospectively, and decided in favor of the Beneficiaries. One panelist considered the decision a “close” case. The case is on appeal and is expected to be heard in May 2024. Other panelists discussed whether use of a discretionary sanctions clause in the instrument by the confirmer would have made a difference. While several commenters said they would expect pushback against use of such a clause in practice, one specialist suggested as an alternative to a discretionary sanctions clause a clause to the effect that “we [bank] are not responsible for delays in payment or non-payment due to laws, regulations or executive or judicial orders applicable to us [bank]” might be acceptable to a beneficiary. For a thorough written summary and analysis of the case, see June 2023 DCW at 15; and for additional insight, see Sept. 2023 DCW at 18.
In Chian Teck Realty v. SDK Consortium, the Singapore High Court considered the matter of fraud and whether the Beneficiary of a performance bond must have an honest belief that the subcontractor (Applicant) has defaulted and owes damages in the amount claimed. The bond also had an auto-extension clause. As a notice of non-extension was sent to an old address and never received by the Beneficiary, the court determined that the notice was invalid. In making its demand, Beneficiary had honest belief that the bond would soon be expiring so the Judge found no fraud on the Beneficiary’s part. The case is summarized in this DCW issue at p. 22.
The panel then explored two cases which offer important lessons for how LC banks can protect themselves against claims that they acted as an advising bank to recommend an issuer or committed to issue, confirm, or transfer an LC. In ERA Capital LP v. Soleil Chartered Bank, Regions Bank was sued for, among other claims, negligent misrepresentation, allegedly stating to its customer, ERA Capital, that Soleil was a good” bank. ERA Capital, Beneficiary of an LC issued by Soleil Chartered Bank which Soleil dishonored, sued. On appeal, the court ruled that the breach of fiduciary claim was properly dismissed, but summary judgment was appropriately denied as to the negligent misrepresentation claim and Regions is required to participate in discovery. Panelists emphasized that banks must set clear parameters for their role as an advising bank. One panelist noted that most banks provide a cover letter stipulating what they are prepared to do as an adivsing bank and another panelist added that a bank should include a liabilty disclaimer in its advice.
In Arif Kahn Global, Inc. v. State Bank of India, the central question was whether SBI agreed to confirm the LC. Text of the case included the wording of numerous email messages between Arif Kahn Global (Akgus) and SBI. Ultimately, SBI pulled out of the dealings and Akgus sued. The court ruled that there was no contract to confirm; instead, SBI communicated in generalities. For panelists, the key practice point from the case is that banks need to be careful they do not expressly agree to confirm when that is not their intention. One banker explained that their institution has pre-set wording with standard verbage and reference that they need to see the LC text. Do banks confirm LCs for non-customers? Some bankers indicated they do not confirm if the beneficiary is not a customer. Other bankers said they look if the issuing bank is a customer and, other than for compliance considerations, are less concerned about the beneficiary being a customer.
SWIFT MT Update & The Future of Trade Messaging
Swift Standards Specialist Mukta Kadam presented to delegates details of the Standards MT Release 2023 that will go live on 19 November and an update on the corporate-to-bank API specifications for guarantees and standbys. The SR 2023 changes are smaller compared to recent past years and do not involve any creation, deletion, or modification of MTs or MT numbers. Among the notable changes, a new Field (31R) has been introduced to handle “Requested New Date of Expiry of Local Undertaking” and the length of four port/location-related fields have been augmented in five Category 7 MTs. With SR 2023 come changes to the MT 798 Message Implementation Guide and FAQs. Based on keen interest among banks in having APIs, Swift joined hands with ICC. For ease, Swift kept the same MT 798 data-aligned resources and functionality but in an API method. A pilot will be undertaken.
Coffee with Corporates
From a corporate perspective, specialists shared thoughts about their expectations and interactions with bankers. In present days, considerable importance is placed on compliance matters but with scant attention on what banks are actually issuing. For KYC requests, corporates expect a bank to have coordinated within so that one request is made of it instead of multiple requests coming from several departments of the bank. In terms of corporates’ wishing that KYC requests could be standardized across the banking industry, this seems unlikely as regulatory expectations of banks are vague in many respects and governmental bodies have said that checklists are insufficient. Deviation from the preferred wording of standbys or guarantees can also present problems for corporates who have format restrictions that cannot be easily changed. Corporates can help their cause by trying to have formats reviewed in advance of the signing of underlying contracts. It is not always possible, but pro-active communication between bankers and corporates can be advantageous. Small irritations, which can add up and cause big frustrations, experienced by corporates of banks include use of miniscule font sizes on invoices, billing errors (i.e. unclear charges), and inconsistent service from bank branches.
Digital Standbys
With standbys typically involving fewer documents than commercial credits, the expectation is that a fully digital standby can be achieved. In this panel, three crucial areas were identifed: 1) How corporates interact with banks; 2) End-to-end processing within banks; and 3) Automating rules and standards. For one commenter, the lack of a central repository whereby each stakeholder can access their part of a standby in a secure way remains an impediment. While inroads have been made by some legal regimes for recognition of electronic trade records, when data moves cross-border from one jurisdiction to another, there will be problems where laws are inconsistent.
Standby Text and Forms Seen & Used in Practice
The bulk of the panel’s discussion focused on a recently revised Electric Reliability Council of Texas (ERCOT) Form which has captured the attention of some segments of the banking industry. While one banker opined that the form is not terrible, there are a few important aspects worth highlighting. The form contains a clause about the issuer being downgraded and another about bank closure. It also includes a termination clause that may not be objectionable, but is notable in that it eliminates the need to even have an expiration date and an evergreen clause. The form states that it is “unconditional”, then goes on to state conditions, including some that are non-documentary. It contains the condition that its issuer “shall maintain a corporate debt rating not less than that required by the ERCOT Protocols”. Other commenters pointed out the form’s failure to reference “banking day”; otherwise, termination or any future expiry date could be on a Saturday. Other complaints expressed by bankers included LC forms received from Europe and the Middle East which require the issuing bank to countersign drawing statements. The clear message to banks willing to use provided forms and templates is that it is their LC that will be issued, and they are responsible for any problems or ambiguities.
Traps and Challenges in Standby & Guarantee Practice
The panel first took up discussion of syndicated credit agreements. Panelists cautioned that some agreements in current use are outdated, inadequate, and do not protect the fronting bank. One panelist explained the concept of what some have termed a “2-in-1” standby which can initially serve as a bid standby and then act as a performance standby for a longer period of time and greater amount. (For more details, see “The 2-in-1 Standby”, Jul/Aug 2023 DCW at 41.) Advocacy for use of such a standby has generally come from beneficiaries and has been seen in the utilities sector. Although familiarity with this type of “2-in-1” standby was limited among those in attendance, some delegates commented they have seen instruments combining performance and warranty. Panelists addressed the question: Does LC insurance offered by the Export-Import Bank of the US cover when there is a disputed or questionable discrepancy and the issuer refuses to reimburse the confirmer? The EXIM LC policy covers commercial and political risk of the non-US issuing bank to pay or reimburse on an LC, but it does not cover documentary risk. In one past experience, an issuing bank rejected a presented invoice because it was blue instead of white. The confirmer was not paid and EXIM refused to cover due to such discrepancy. Other commenters concurred that EXIM will not get involved such disputes.