ICC Digital Library Forum

What does the disclaimer provide and how should the document checkers handle documents presented under a transferred documentary credit?

When the draft of UCP 500 was circulated for national committees' comment, bankers anxiously expected a document that could remove the numerous problems encountered in documentary credit operations. However, there are still clouds pending clarification.

For years, banks in Hong Kong have handled large volume of transfer documentary credits due to proximity to the emerging market of China and South East Asia. The writer, have been working in a commercial bank in Hong Kong for over twenty five years wish to share with you his experience in one of those dark areas.

Among the articles of UCP500, Article 48 is the sole article dealing with transfer of credits. There are several complaints on the insufficiency of provisions for transfer of credits given in the UCP. On the other hand, the complexity of legal concept of transfer and assignment as well as the liberated market practice add further confusion thereon.

The first issue that I wish to discuss is the disclaimer clause added to the advice of transferred credit by the transferring bank. It has been developed as a common practice in Far East that a clause indicating payment under the transferred credit will only be made upon receipt of funds by the transferring bank is added on the advice of transfer. (In which case it is also the nominated bank for negotiation of transferee's documents.) This type of disclaimer attacked queries to ICC for comment. The Commission on Banking Technique and Practice responded with its opinion that such clause does not constitute violation to the UCP and is solely the nominated banks' expression of their intention not to provide negotiation and finance to the second beneficiaries. I am of the similar view with the Banking Commission except that when the credit bears the confirmation of the nominated bank.

In order to have a clear picture, I would like to sit back at the basis of the documentary credits. There is a contract between the issuing bank and the beneficiaries of the credit. A transfer of documentary credit is a transfer of contract where one of the contracting parties passes his/her rights and benefits of the contract to an independent third party. Article 48 a & b confirm with the general principle of contract law that transfer should only be effected with the consent of all parties concerned by limiting the effects to documentary credits expressly designated as "transferable" by the issuing bank (Art. 48 b). There is no statutory requirement for formality of transfer of contract. However, in international trade finance context, the nominated bank is involved to authenticate and advice the transfer to the transferee. In case of partial transfer, the transferring bank will also reproduce an operative instrument for transferee's usage. Art. 48 a states, `¡K.to make the Credit available in whole or in part to one or more other Beneficiary(ies) (Second Beneficiary(ies))' As per Art. 48 c, the transferring bank (the bank nominated by the issuing bank for effecting the transfer) shall be under no obligation to effect such transfer except to the extent and in the manner expressly consented by such bank. If it elects to advise the transfer, the bank shall take reasonable care to check the authenticity of the credit and the requesting party as well as adhering to the instruction from the issuing bank (principle). Under this provision, the transferring bank may lay down some pre-requisite and or terms for such transactions, including reservation of rights for declining beneficiaries' (either or both first and second beneficiary's) request for negotiation in future. Unless the credit has been confirmed by or undertaken by the transferring bank, advise of transfer does not engage the bank in any liability(ies) and obligations under the credit. Adding of such disclaimer does nothing changing the position of the transferring bank. It can still change its mind subsequently.

Subsequent to effecting the transfer of credit, it will be our checkers' turn facing uncertainty regarding checking of documents. Since the incorporation of the provisions for transfer of credits into the previous versions of UCP, there have been arguments about whether the transferring bank is required to check documents presented. Despite that some banks may have clear guidance in their procedure manual for checking documents presented for negotiation under other banks' documentary credits and their own credits, there are still queries asked about the proper approach for checking documents presented under transferred credit requiring substitution of documents.

According to my understanding, there is no standard approach among banks. Many banks do not check any documents and simply forward the documents to the issuing bank for approval and payment after substitution of documents by the first beneficiary. They argue that, with the disclaimer, they have no liability to any party including the second beneficiary(ies) and their client (first beneficiary). Some of them even alleged that, by presenting documents thereunder, the beneficiary(ies) accepted the provision of the disclaimer and waived all their rights under the original credit. Some banks may check the documents after substitution. Some other banks may exercise a prudent approach by checking all documents presented irrespective of the presenting party's position and issue discrepancy notice as usual.

Since Art. 48 does not mention any words regarding documents checking, we have to look into the rest of the UCP for guidance. Art. 13 a stipulates that, `Banks must examine all documents stipulated in the Credit with reasonable care,¡K¡K' Is the transferring bank included in the `Banks' of Art. 13 a? The answer depends on how the transferring bank is going to deal with the documents. If the transferring bank is requested by the presenter to forward the documents to the issuing bank for approval and payment, it will act as a collecting bank in the transaction. Reading in conjunction with Art. 13 b, a collecting agent does not fall within the meaning of the `Banks' of Art. 13 a. In case the transferring is going to negotiate the documents for the presenter, then it will be obliged to check documents as per Art. 13a. In our daily practice, it is not strange that most of the documents presented are not accompanied with clear instruction of the presenting bank. Most of the documents that we received are attached with a cover schedule stating some brief information of the transaction, such as amount, tenor, name of drawer and D.C. number¡Ketc, and reimbursement instructions for disposal of proceeds only. The intention of the presenting bank is seldom expressed therein, whether for ongoing presentation on approval and payment or negotiation. Such ambiguous presentation contributes to the cause of common mis-concept that appear nowadays.

Moreover, in a transferred credit transaction with substitution of documents, the situation becomes more complicated. Even in a transaction that negotiation is not required, the transferring bank still owes its clients duties of care. It has to ensure that second beneficiary's(ies') right should never be jeopardized. The transferring bank, whilst substituting second beneficiary's documents by the first beneficiary's, should not allow any deterioration to transferee's position. For example, discrepancy should not be allowed due to insertion of transferor's documents. Therefore, the transferring bank, at the least, has to make sure that the content of the documents submitted by the transferor are corresponding to those of the transferee's, except those allowed by the Art. 48 h, such as amount and unit price.

There are still many interesting topics relating to practice of handling transferred documentary credits for discussion in the future. I hope that the readers will give feedback to the above opinion and generate further discussion about the issues of transfer of documentary credits.

Interesting post and by far the longest!

I have a couple of points in response:

a) The 1st ben keeps certain rights under the transferred l/c-he does not simply drop out. For instance, he might retain the right to reject amendments; he will be claiming balance due to him; he still has separate contract with applicant
b) If the transferring bank is the nominated bank its duties to the 2nd ben should be the same as to the 1st ben prior to transfer
c) Agree that if transferring bank not checking docs (i.e. l/c payable at I/B's counters)it still has responsibility to make reasonable efforts to ensure that invoice/draft substitution is effected without jeopardising 2nd ben's position.

Article 48e adds to the confusion already sighted in this forum. When should the first beneficiary confirms his / her agreement to an amendment to a letter of credit that is subject to transfer to more than one 2nd beneficiary? Is it after receiving the consent of all the 2nd beneficiaries? What if one of the 2nd beneficiaries rejected the amendment after the first beneficiary presented documents that comply with the amendment? e.g. by substituting documents for the other 2nd beneficiaries who acted in accordance with the amendment. Should the first beneficiary informally obtain / secure all the 2nd beneficiaries approval and then authorize the transferring bank to transfer the amendment to the 2nd beneficiaries? What happens to the applicant who requires the amendment to be carried out in full or rejected in full? Some of the transferable credits cover only one type of supply of goods or services but the beneficiary may transfer the LC to more than one second beneficiaries and this would affect the applicant if all 2nd beneficiaries did not carryout the amendment. Some projects won’t be completed unless the amendment (e.g. changes in design, parts etc)is carried out by all parties involved. The applicant may end up having two designs or two types of parts, the new and the old.

Who compensates the transferring bank, if he ends up having three or four distinct letters of credit after transferring the master letter of credit, to several 2nd beneficiaries, which was subject to several amendments that were accepted by some of the 2nd beneficiaries and rejected by the others. In this case one 2nd beneficiary can accept a particular amendment and reject another. Theoretically, each 2nd beneficiary may end up having a secondary LC that may in many aspects different from the master LC and / or the rest of the 2nd beneficiaries secondary LC’s.

I have seen banks trying to avoid going into this dilemma by excluding article 48e from the LC terms and conditions. Thus although they deprive each of the 2nd beneficiary the right to solely accept or reject an amendment (if the LC is transferred to more that one 2nd beneficiaries), they allow collective acceptance of the amendment and put the onus on the first beneficiary to ensure its acceptance by all parties involved. How the first beneficiary and 2nd beneficiaries would secure this is left to them to find out.

To avoid all these confusions, the ideal thing would be is to have a transferable LC transferred in its entirety to one second beneficiary. The first beneficiary should not retain any interest to the LC once it approves the transfer (similar to ISP98 article 6.02). The first beneficiary may secure his / her profit margin by concluding another agreement with the applicant or the second beneficiary. Another alternative would be to have the LC available with only the issuing bank and the issuing bank carries out the transfer as well. Although the second alternative does not seem to be practical in international trade, it, in my opinion, does help in controlling the transferable LC in a better shape.

In addition to the confusion in this article, a lot of parties involved in transferable LC do not seem to understand the concept stated therein. Some of them would like to change the entire letter of credit terms and conditions such as payment terms, documents required etc. In addition, I have seen a lot of LC’s in favour of beneficiaries in the Far East designated as transferable LC which contain a condition that third party documents are acceptable. To make it even worst, the term “third party document” is not defined in the LC and one may confuse between third party issuers of documents or third party name on documents or both are allowed.

I agree that there are a lot of topics to be discussed on transferable LC practices and hope we receive feedback from the rest of the community.

When an issuing bank opens a transferable l/c it (and the applicant) must be aware of the risks involved if the 1st ben chooses to transfer the l/c to more than one 2nd ben and must live with any potential consequences.

Art 48e is clear on the matter but, as stated above, the applicant could be left in an awkward situation.

In my view excluding Art 48e is unworkable since each transfer is a separate independent contract. 48e effectively states the legal position.

If the applicant is concerned that his transferable l/c could be transferred more than once he can instruct the issuing bank to state on its l/c that it may be transferred to only one 2nd ben (i.e. overriding last part of 48a)

I am in the view that the banks that exclude article 48e may have a point. After all, article 48e is covered in UCP 500 only and the letter of credit community was living without it for quite sometime. The addition would have been made to protect the rights of 2nd beneficiaries but not to put the applicant and /or the first beneficiary rights in jeopardy. ICC Publication 511 (UCP 500 &400 compared), on the last lines of page 126, provides that if the issuing bank and the confirming bank don’t wish to allow a separate and unilateral acceptance by the 2nd beneficiaries to an amendment then they should clearly state how the amendments to the credit and to the transferred credit is processed. Although this does not state or give an example on how the amendment could be carried out, it, in my opinion, implies that effectively excluding article 48e while maintaining the features of multiple transfer is workable provided the credit stipulates how the amendments are controlled to provide a collective acceptance or rejection of any of the amendments.

Another issue that needs clarification is how would the transferring bank act if the 2nd beneficiary presents complying documents and the first beneficiary substitute the invoice and the draft with discrepant documents with an instruction to obtain applicant’s waiver of the discrepancy (ies)? Would the transferring bank ignore the first beneficiary’s request to obtain waiver of the discrepancy to protect the 2nd beneficiary from losing his / her right under the LC in case the discrepant documents of the 1st beneficiary is presented just before or on the expiry date of the master LC?

Would the issuing bank has the obligation to pay/accept documents re-presented by the transferring bank after the expiry date of the master credit even if the issuing bank has refused the first presentation of the same documents by the transferring bank due to discrepancies in the first beneficiary’s invoice and/or draft i.e. if the transferring bank subsequently forwards the 2nd beneficiary’s complying documents to the issuing bank with an indication that the 2nd beneficiary’s documents were presented within the validity of the transferred credit? Feedback on these comments and / or other issues related to transferable LC’s would be appreciated.

If the 2nd ben presents documents (to the place named in the l/c) in conformity with l/c terms then that is enough to trigger the issuing bank's obligations to make payment. From the 2nd ben's perspective he simply has a letter of credit issued by X Bank in his favour. All he has to do is comply with the l/c terms to obtain payment.

The subsequent performance of the 1st ben in correctly/incorrectly substituting docs is of no concern to the 2nd ben.

Agree with u in regards to 2nd beneficiary's concerns provided he/she has complied with the transferred LC terms and condition. My question is how would the transferring bank act when it is put in the situation explained above. would the bank comply with the request of the 1st beneficiary and apply for a waiver of the discrepancy or deprive the 1st beneficiary from this right? If it elected to comply with 1st beneficiary's request and both applicant and the issuing bank rejected the documents, would the beneficiary be able to present the 2nd beneficiary's documents or it would get stuck with it?

Assumption: LC transferred with the right of the 1st beneficiary to substitute invioces and drafts is retained.
Issuing bank and applicant are not aware that the LC has been transferred. No such requirement in the master LC.

The 1st ben would quite useless if he were unable to produce just a correct draft and invoice or then quite stupid if he didn't want to correct a mistake.

Where Art 48i refers to 'first ben is to supply his own ....' it must mean that these substituted docs should be in conformity with the l/c. If they're not, the rest of the Art applies i.e. the first ben has effectively failed to deliver the docs on first demand and, therefore, must suffer the consequences.

Agree with PGauntlett and thank him/her for the well thought answers. The scenario given is just hypothetical but we should not rule out that this could happen in reality. For one reason or the other the first beneficiary may not be able to produce complying documents. In some other situations, the first beneficiary and the transferring bank may oversee the discrepancies and will only be aware of the them after receipt of discrepancy notice from the issuing bank. This notice maybe received after the expiry date of the master LC but within the period allowed in article 14(d). Would the transferring bank then be able to substitute the 1st beneficiary’s document with that of the 2nd beneficiary’s or get stuck with them? Let’s assume that the applicant went bankrupt, taking the situation stated above as a pretext, would the issuing bank be able to reject the documents?

Assumption:
2nd beneficiary’s documents are in order.
Credit expires at the counter of the transferring bank.
LC is not confirmed but available with the transferring bank.

Thanks for your valuable feedback to my opinion.
For transferred letters of credit, the principle of how letters of credit operates remains the same as if they have not been transferred except some procedures which are designated for the middleman (first beneficiary) to draw for his portion of profit.
In multiple transfer situation, i.e. when a documentary credit is transferred to multiple transferees (more than one transferees), the original relationship of a single contract between the issuing bank to the original beneficiary is divided into several contracts between the issuing bank and the `beneficiaries'. The question of whether the first beneficiary remains a party to the contract depends on his selection of options available in Art. 48d. In case the first beneficiary retains his rights to refuse to all the transferring bank to advise amendments to the second beneficiary(ies) The term `beneficiaries' in the above sentence will include both the first beneficiary and the respective second beneficiary(ies). Therefore, an amendment to a documentary credit, which has been transferred should become effective when it is consented by all parties concerned including the `beneficiaries' as explained above.
In practical sense, there should not be any requirement regarding the sequence of acceptance by the first and second beneficiary to any amendment.
To the point of second beneficiary's right of accepting any amendment, I wish to say that it is their responsibility to decide whether to accept the transferred D.C. stating that the first beneficiary retains his rights to amendment. This is the most fundamental concept of contract law, i.e. freedom to contract. Once he accept such documentary credit, he should aware the situation and bears the risk.
I totally agree with Pgaunlett's view that any presentation referred in Art. 48 means presentation of documents conforming to the D.C. terms. I would like to reiterate my opinion that the transferring bank owes the duty of care to its clients, both the transferor and transferee. It also owes the duty and responsibility to the issuing bank and is required to check documents with reasonable care under Art. 13 a. Should the transferring bank allow the first beneficiary's discrepant documents for substitution of the conforming documents presented by the second beneficiary with knowledge of the discrepancy(ies), it breaks its fiduciary duty to the second beneficiary. In case it oversights the discrepancy(ies), it should be blamed for not performing upto international standard and fails in exercise due care. Under both situations, the transferring bank should be accountable for the damage to the transferee.
On the other hand, the issuing bank, upon receipt of documents, should handle the documents as usual. In order to avoid ambiguous, the issuing bank insert a clause into the transferable documentary credit asking the transferring bank to advise them at time of effecting transfer of the D.C. Once the issuing bank is aware of the transfer, most of the clouds will be cleared.