Resources Profile - Catalyst

During the revision of the UCP this issue was a subject of intense discussion at the meetings of the Drafting Group and the National Committees when they discussed the issue of ‘parties’ or ‘banks’.

It may be worthwhile to summarise the opinion of the ICC on this subject for the benefit of the members. What the ICC has put forward is as follows:
1. There is no affirmative rule in the UCP prohibiting non-bank entities from issuing, confirming, paying, negotiating, or advising letters of credit, or from submitting themselves to the provisions of the UCP.

2. Neither the Commission on Banking Technique and Practice (the Banking Commission of the ICC) nor the UCP can determine who is empowered to issue letters of credit under local law, nor who may issue its undertakings subject to the UCP. This is a local regulatory matter.

3. However, in all its articles, the UCP refers only to banks. In UCP 600 it was decided that the UCP would continue to be for the banks only. That is, the rules will apply only to banks.

4. There are three principal advantages to LCs issued and handled by banks. These are:

(i) Operational expertise to handle issue and presentation under letters of credit in a professional manner.

(ii) The tradition of independence from the underlying transaction (the banks are not involved as parties to a transaction). This is the very basis of the reputation and success of LCs as the most accepted mode of settlement, and the reliability of banks as issuers. Where LCs are issued by non-banks, they also happen to be interested parties.

(iii) In virtually all countries banks are specially regulated with a view toward protecting those who rely on their undertakings. The same cannot be said of non-banks or corporates who wish to issue LCs.

5. The neutrality of the issuer is a risk that could be severely compromised when the importer is simultaneously the issuer of the LC. (Such an LC adds no value to the transaction or to the contractual obligation between the parties concerned, since the buyer can provide no better comfort by offering an LC to the seller, when the LC is issued by himself.)

6. If a bank is requested to advise an LC issued by a non-bank, such an advice should accurately identify the issuer and indicate the advising bank's limited role. (This is important...) The advising bank should affirmatively disclose the non-bank status of the issuer in order to correct any mistaken impression about the origin of the credit.

There have been no discussions on this subject on this forum. But if such "LCs" are indeed received by any 'beneficiary', I hope the position, his response and course of action would be clear from this article.

All bills are made up of documents. These are either (1) financial documents, or (2) commercial documents. Bills containing only financial documents are called “clean bills” (most of us are familiar with them).

Bills that comprise financial and commercial documents or of *only* commercial documents are known as “documentary bills”.
All bills sent through banks are drawn either under a letter of credit (LC), or without the use of a letter of credit.

Most LCs are governed by certain set of Rules called Uniform Customs and Practice for Documentary Credits (UCP). These Rules are formulated by the International Chamber of Commerce, Paris. Currently, UCP ICC Publication No. 600 (in short, UCP 600) is in operation with effect fro 1 July, 2007.

Care: Every LC must clearly state whether it is subject to UCP 600. Some countries - and hence their banks (very few, but they exist) - do not subscribe to the UCP. International traders and banks must be careful to identify such countries’ LCs since they would not have the protection of the ICC Rules.

Regarding bills – documentary or clean – the world is divided into two clear hemispheres. All bills are drawn either

(1) under an LC or
(2) *not* under an LC.

If drawn under an LC, these bills are subject to the provisions of UCP 600. If not drawn under any LC, these bills are subject to Uniform Rules for Collection, ICC Publication No. 522 (URC 522). As with LC bills, the bank’s forwarding letter must state accordingly to get invoke the provisions of URC 522.

Exporters, importers, bankers, export managers, trade finance executives should be familiar with the provisions of URC 522, as they should be with UCP 600.

URC 522 contains some very important provisions that are critical to their business operations and international trade payments. More on URC 522 in another article.

PURPOSE VIS-À-VIS PROCESS

I have seen discussions and debates on differences between LC and TT, TT and DP/DA bills etc. This article is to put the subject in its proper context.

We must note the distinction between the PROCESS (of moving money) in contrast to the PURPOSE (that generates or causes the movement). The first is answered bythe question "WHY"?, The second by the next question "HOW"? One very often fails to distinguish between the two. This is an area that happens to be confusing to many. Consequently, questions like "What is the difference between a TT and a D/P bill", or "While negotiating with my party, should I opt for TT payment or pay by LC?" keep cropping up during discussions at various forums or workshops. It is imperative that the basic concepts are clarified.

Cause and effect
-------------------------
The purpose or the transaction prompting the transfer of money (WHY transfer?) can be any of the reasons conceivable. Some examples: purchase or sale of goods, payment towards services, expenditure on capital goods, fixed or movable assets, expenditure on travel, gift or charity, deposit of cash or transfer to an account for savings or investment. There could be a million plus one reason giving rise to the transfer of money.

The next stage comes where we see money actually being transferred from one place to another, from one account to another, or from one bank to another. A physical movement takes place where the one who has the money (the remitter) foregoes possession in favour of another (the beneficiary) who then gains possession of it. How this physical movement takes place determines the process of transfer.

The remitter or the beneficiary may decide how exactly the physical action of movement of funds is to take place. The factors that guide such decision include the urgency, available technology, settlement procedure, cost of remittance, associated risks and mutual convenience.

We are familiar with several of these processes of fund transfer. These include electronic transfer viz., telegraphic transfer (TT), S.W.I.F.T., ECS, RTGS etc., or transfer using a physical mode viz., mail transfer (MT), cheque, draft, cash, banker's cheque, pay order and so on. These are HOW money is transferred. We often discuss purchase and sale, export and import - where one party parts with goods or services in exchange for money from the other. We also discuss about some of the terms of settlement between the buyer and the seller. One should remember that bills and LCs are only documents that represent a transaction. They are neither purposes nor processes.

Advance payment, for example, is a purpose ("WHY?"); the advance payment being effected ("HOW?") by means of a TT or a bank draft is the process that translates a purpose - to bring the former to a conclusion. The cause has nothing to do with the choice of the process (or the method, how?) that one may use to consummate that cause. Conversely, the cause (the purpose or reason for transfer of funds) may be only one, but the processes that one may select, or the options to choose from (to effect the transfer)  could be several.

The important thing to remember is to distinguish between the purpose of a transaction against the process to conclude the same.
Ask yourself "WHY"? and then send the remittance by answering "HOW"?

ESTABLISHING BACK-TO-BACK CREDITS

This is how the whole process works.
1) Issue of original LC
In documentary credit operations the buyer (i.e. the applicant) arranges to establish the (original) credit through a bank (the issuing bank or the opener) in favour of the seller (the beneficiary). The buyer and the seller are the primary parties to the contract for the specific transaction. The issue of a credit is advised through a bank (called the ‘advising bank’) usually located in the city of the beneficiary. The beneficiary receives the original credit through the advising bank and/or his own bank.

2) Issue of Back-to-Back LC
A back-to-back credit is (only then) established when the seller-cum-original-beneficiary, after receiving the notification about the issue of the original credit, arranges for a second, stand-alone credit to be established in favour of the (actual) supplier/manufacturer of goods or raw materials. Accordingly, and usually based on the original credit, the advising/confirming bank issues its own letter of credit – generally with terms exact or similar to the first i.e. the original LC (hence the term ‘back-to-back’) - except for alteration of beneficiary, expiry date, and invoicing requirements, if considered necessary.

3) No formal connection between the two LCs
Please be careful to note that there is no legal or formal connection between the ‘original’ LC and the ‘Back-to-Back’ Credit. Each credit stands on its own merit. The terms and conditions of the two are not the same because one has to make sure that the documents coming forward under the second credit come forward in such a form and in such a time that they can be presented under the first credit within the expiry date and in accordance with the terms and conditions of the first credit.

4) Back-to-Back LCs can be opened as a chain
If there are several middlemen (or manufacturers who must again procure input materials from other manufacturers), each may use the credit in his favour as security for the credit that he has to open in favour of his supplier in the chain of contracts, until first buyer in the chain has effectively opened a credit in favour of original supplier. In this chain, each credit – except the original one – is termed a credit that has been issued ‘back-to-back’ to the previous one.

WHEN IS BACK-TO-BACK CREDIT REQUIRED?

A ‘back-to-back’ arrangement may become necessary where the underlying contracts are on terms that do not match, or where a Transferable Credit is unable to maintain secrecy on a particular aspect of the transaction.

Need for such a credit may also arise where –
a) ultimate buyer is not ready to open a transferable LC,
or
b) beneficiary is not ready to disclose or divulge to buyer source of his supply,
and
c) the manufacturer insists on payment against documents or goods but beneficiary is short of funds.

BACK-TO-BACK CREDIT NOT A PART OF THE UCP

Back-to-back Credit finds no mention in the UCP. Only transferable credit is mentioned. Therefore no specific or separate rules apply to back-to-back credit. (This should be evident from the fact that each LC is an independent entity and stands on its own footing.) A bank must treat each stage of the operation as a separate transaction, each legally independent of the other. Consequently, the issuing banks concerned must independently assess the risks and liabilities associated with issuance of each of the credits separately.

A CREDIT DECISION OF THE ISSUING BANK

The applicant for a Back-to-Back Credit takes off his hat as the beneficiary to the original credit and wears the hat of an “applicant” as far as the back-to-back credit is concerned. It is important to note that a bank may agree to issue a back-to-back credit only when the applicant-beneficiary is considered – in the eyes of the advising bank (the issuer of the second, i.e. the Back-to-Back Credit) – to be creditworthy on his own right. The decision by a bank to issue a (Back-to-Back) credit is neither a matter of right nor is it automatic – especially not just because a seller-cum-applicant in the chain happens to be in possession of another (the original) documentary credit as a beneficiary of the original credit.

UTILISATION: SAME AS WITH ANY NORMAL CREDIT
Since the back-to-back credit is an independent credit and because here we are not dealing with the transfer of a credit as defined in Article 47 (ICC 500) of the UCP, the practices and procedure for utilisation of a back-to-back credit would be the same as in the case of any LC. The documents required are, therefore, presented in the normal course by the beneficiary via his bank to the original advising bank. The documents are honoured – provided they conform to the terms of the back-to-back credit – to the debit of the intermediary (i.e. the original beneficiary who initiated the issue of the back-to-back credit).

Caution: The intermediary bank should not take comfort in the fact that the credit under which the documents are being handled is a “back-to-back” credit, thus causing it to be lax in recovering funds from the intermediary towards documents so received under its own (back-to-back) credit.

SUBSTITUTION OF DOCUMENTS

At this stage the exchange of invoices (and drafts, if any) is a must, because – contrary to the transferred credit – the original credit opened in favour of the intermediary / middleman cannot be negotiated by simply using the documents of the supplier. The actual supplier in the chain has no locus-standi as far as the applicant to the original credit is concerned.

Any other differences allowed in the opening of the back-to-back credit must also be eliminated at this point.

NEGOTIATION AND PAYMENT
After these changes have been effected, the documents are used for negotiation of the original credit and the proceeds are credited to the account of the intermediary / middleman (the original beneficiary) in the usual manner. Procuring, exchange and substitution of documents and the process of negotiation may now continue up the chain in the normal course.

I beg to disagree with your reasoning. Reasons are as follows.

Please refer article 6.d.i. It says, “A credit must state an expiry date for presentation. An expiry date stated for honour or negotiation will be deemed to be an expiry date for presentation.” Therefore, expiry date of LC = last date for validity of LC = last date for presentation = last date for honour or negotiation. It (the last date) applies unconditionally, uniformly to the negotiating bank, to the confirming bank, AND to the issuing bank. Wherever the document is presented, to whomsoever it is presented, to whichever bank it is presented, it must be presented (as a complying document) WITHIN this date. Otherwise, no honour, no negotiation.

(1) Hence, presentation to the issuing bank on 14th July is an INVALID presentation. LC has expired on 10th July!

(2) Period of presentation, if not stated in the credit, is limited to 21 calendar days after the date of shipment, but presentation MUST be made within the validity of the credit. (Article 14.c, UCP 600). [Irrespective of whatever Field 48 states. Incidentally, this “Field 48” is not referred in UCP, therefore to be ignored.]

(3) Regarding your statement that “Bank still has its ‘payment’ time frame that is 5 banking days ….etc.”, I beg to disagree. Negotiation or honour is same as payment (for sight bills under sight LCs). One goes with the other. A bank can’t *negotiate* today, and *pay* after 5 days!

(4) Now your assertion: “Upon receipt of the documents by the issuing bank in, it will check the date indicated on the covering schedule ….”.

I presume that by “the date of presentation for negotiation, payment, acceptance or deferred payment undertaking” you are referring to such dates with particular reference to the bank at the seller’s/Beneficiary’s end. If that be so, the presumption is incorrect.

Article 12.(c) clarifies that mere “Receipt or examination and forwarding of documents by a nominated bank … does not constitute honour or negotiation.” In the example that you have given, the beneficiary’s bank has effectively acted as a mere post-office, no more. Hence, the provisions of UCP 600 DOES NOT apply to that bank (therefore, its date of receipt etc. are irrelevant). Consequently, the test of your statement “whether or not the documents are presented to the bank in is made within the expiry of the credit” can ONLY be with reference to the issuing bank.

(5) Therefore, if a complying presentation has to be made by the beneficiary (or on his behalf), the issuing bank must receive the documents BEFORE the LC expires. The date of receipt by the beneficiary’s bank (or any other bank THAT HAS NOT HONOURED OR NEGOTIATED) is totally and absolutely irrelevant to any documentary credit operation or the UCP. (apologies for the emphasis used.)

(6) I agree with your statement that “so long the documents are presented to any negotiating bank and within the expiry date of the credit, the bank is obligated to examine the documents” but only in parts. As per the provisions of the UCP, any bank – including a “nominated bank” - can examine, but need not honour or negotiate (refer Article 12), unless it is an issuing bank (Article 7.a.i), a confirming bank (Article 8.a) or a nominated bank that has “expressly agreed to honour or to negotiate” (Article 12.a) – (but only) a complying presentation.

(7) Finally, the matter of the five days that is now permitted under article 14.b of UCP 600.

The whole point of my article was only this: Now that (i) each bank (whoever gets the documents, the negotiating bank OR the issuing bank) is allowed 5 days from the day after the date of presentation, (ii) the term “reasonable time” has been removed, (iii) and the second sentence has been added to the UCP, what would the impact and the implications be? For, to the best of my understanding, if the LC expires before the 5 days are over, tough luck for the presenter. He should have presented the documents (at least) 6 days ago! Is that what the UCP is now saying?

Therein lies the problem (and the land mine)! I am afraid that the land mine is still there!