Corporate Finance Involving Law - Essay Example

?Q Saida agrees to deliver a consignment of cement to Khalil, CIF Cape Town, April shipment. Payment is to be made against documents. Khalil instructs his bank, Small Bank plc, in Cape Town to issue a letter of credit in Saida’s favour. Big Bank plc in England is asked by Small Bank to act as advising bank but Big Bank has promised Saida to add its confirmation and not disclose this fact to Small Bank. Big Bank plc informs Saida that a letter of credit, subject to the UCP600, has been opened for “?200,000 payable on sight against bill of lading for 10,000 tonnes (plus minus 5 %) of 98%-pure cement as per sale contract, April shipment, invoice and insurance documents”. Saida tenders to Big Bank plc a pre-printed “shipped on-board” bill of lading with an issuance date of 31 March. There is also a notation referring to “10,002 tonnes Class A cement fully loaded on 1 April with 5% on deck”. Saida has also tendered a word-processed cover note referring to 10,000 tonnes Grade A cement marked “as original” but not signed, and an invoice for “approximately 10,000 tonnes high grade cement”. It is generally known in the industry that Class A means cement with a purity percentage of at least 98%”. A surveyor’s certificate is also tendered which states that the cement is slightly discoloured. Big Bank has reservations about the documents and pays Saida “under reserve” and “without prejudice”. Armita, Small Bank’s manager, refuses to reimburse Big Bank on the basis of non-compliance. She also suspects that the date entered by the shipmaster on the bill of lading is false. Armita also demands to see a certificate of origin because it is her bank’s policy not to deal with goods emanating from certain countries. Saida has also contracted to sell a consignment of sulphur to Turhan. The contract requires Saida to secure for Turhan’s benefit, a performance guarantee to the amount of ?30,000 issued by Nidhi Bank, a bank in London, England, guaranteeing Saida’s performance. That guarantee is expressed in the following terms: “We undertake to pay you on your assertion of Saida’s default or breach of Contract No 34/06 in writing being received at this office and bearing our reference Guarantee No 666/05A ... ” Saida refuses to ship when she discovers Turhan has failed to open a letter of credit in her favour. Turhan’s bank has declined to issue the letter of credit because of liquidity problems. Turhan makes a demand under the guarantee on Nidhi Bank by making a statement asserting Saida’s failure to ship but the demand refers to "Guarantee No 666/05". Discuss the rights and liabilities of the parties under English law. Ans# Trade credit is often used as a method of payment for both the domestic as well as the international trade business. However, it is mostly used in international trade considering the overall risks involved in the international trade transactions as well as the role of banks in facilitating the payments between the parties. As such the credit used for the purchase and financing of the inventories and current assets is called short term credit whereas the credit used for the financing of the capital expenditure is considered as the long term finance and both types of finances can be availed through international trade transactions.1 It is important to understand however, that the payments in the international trade finance are often governed through different laws. Most importantly laws and regulations set by the International Chamber of Commerce or ICC are considered as binding on the parties involved in the international trade transactions. The major set of rules governing the international trade transactions include UCP 600 which actually provide a detailed overview of the rights and obligations of each party to the transaction in the international trade besides governing the swift completion of such transactions. 2 Under UCP 600, not only the rights and obligations of the parties are outlined but the overall role and responsibilities of the banks and financial institutions have been outlined too. As such UCP forms the basis of the conclusion of transactions under the international law and as such also reflect various legal decisions made over the period of time.3 The given situation therefore needs to be largely viewed from the perspective of rules formed under UCP. Major Issues Before discussing the rights and liabilities of the parties, it is important to discuss the rights and liabilities of each party to the transaction. Bill of lading contains the entry date of 31st March however, the shipment was supposed to take place in April. 1. Cement is not according to the description provided in the cover note. It is also important to note that no packing list has been providing confirming the exact nature and quantity of the goods to be shipped under the documentary credit. 2. There is a discrepancy in the quantity mentioned in the documents. 3. Certificate of origin is not included with the documents 4. Turhan’s failure to open a letter of credit. 5. Number of guarantee in Turhan’s claim is not exactly as it was written in the performance guarantee issued by Nidhi Bank. The above are some of the issues which can actually outline the key legal disputes between different parties and resultantly can define the rights and obligations of each party. It is also important to note that there are two different situations outlined in the case under which one situation specifically deals with the documentary credit whereas other is regarding the issue of non-complying with the performance guarantee. Under these two situations therefore the overall rights and obligations of each party to the transaction will be defined under ICC rules and regulations as outlined in the UCP 600 and different cases settled by the court of law. Examination of documents According to Article 20 of the UCP 600, the date of issuance of the bill of lading is also considered as the date of shipment.4 Accordingly, it therefore outlines that the shipment will be affected the day the bill of lading has been issued by the shipping agent. According to this clause, it is therefore evident that the date of shipment mentioned in the bill of lading submitted is 31st March whereas according to the terms of the documentary credit, the shipment to be affected in April. Accordingly, there arises a discrepancy in the documents and as such the reimbursing bank may not be obliged to honour its commitments owing to the discrepancy in the document if that discrepancy is already not removed or duly communicated5 Further, according to Article 14 of UCP 600, it is mentioned that though data in the document and credit along with the rules may not need to be identical in nature however, the data must not conflict with the data mentioned in other documents. 6However, the situation described in the case indicates that there are some differences in the information presented in different documents which is directly in conflict with each other. For example, as per sales contract, the terms were based on CIF however; the letter of credit mentioned the terms invoice and insurance thus not including the clause of freight into it. Such discrepancy in the data therefore may not entitle Saida to actually claim payment against such credit. Further, under article 28 of the UCP 600, a cover note is not accepted however, in this case a cover note has been presented outlining different details. As such the L/C issuing bank may not be obliged to pay under the terms of the credit. However, the liabilities of both the seller as well as the buyer can still stand considering the fact that the goods have been shipped by the seller. Under the sales of goods act and contract act, the contract between the buyer and seller will remain intact and both the parties to the contract will have to oblige their individual rights and obligations. Further, according to Article 34 of UCP 600 Bank is under no obligation to assume any liability based on the accuracy and sufficiency of the documents presented. Further, it is also not liable regarding the weight and the quality as well as quantity of the goods mentioned in the contract. Further, it is also important to note that a bank is also not binding for the terms of the contract as the contract and the documentary credit are two different aspects.7 It is however, also critical to note that the rights and liabilities of the Saida and Khalil can arise under the sales of goods act. Difference in the quality and description of goods Under Section 14 of the Sales of Goods Act, it is implied that the goods to be sold under the contract of the sales should be of reasonable quality and according to the description. This section therefore outlines that the goods should be of identical nature as described under the contract of sales and if there is any deviation, the buyer has the right to refuse to take the delivery. Under the given situation, it is evident that there is a conflict in the quality of the goods as the goods dispatched are relatively different from the goods sold under the description made in the sales contract. It is also however, important to note that under section 15 A of the sale of goods act, if the change is relatively small or negligible, buyer may not consider it as a breach. According to article 20 (c) of the UCP 600, a bill of lading may contain the details about the goods if entire shipment is covered under the one bill of lading. 8However, if there is a conflict in the information presented in the documents, different parties to the contract therefore may not be entitled to any of the benefits to be enjoyed under the contract. Certificate of Origin According to UCP 600, LC requires a certificate of origin and as such any credit must contain the reference to the origin of the goods from where they are being manufactured. Both the LC as well as the certificate must therefore contain the origin and both shall correspond with each other. If it is mentioned under the credit that certificate of origin has to be with the documents, it is therefore binding on the exporter to attach the certificate of origin of goods. Under the given situation, it has been mentioned that the certificate of origin is not accompanied with the documents and the manager has actually demanded the certificate of origin. As such there are two important legal implications in this i.e. the violation of the UCP 600 rules as the credit did not contained the certificate of origin whereas under the laws where the bank is working, certificate of origin is considered as necessary in order to ensure that the goods are manufactured in the country which is allowed to trade with the country where the goods are actually shipped. It is critical to note that the certificate of origin show where the goods are not manufactured and not from where the goods are shipped. It is also important to note that under section 16 of Sales of Goods Act, it is important to ascertain the goods and without ascertaining goods it may not be possible to enforce the contract of sales because unascertained goods i.e. goods without the proper origin may not be acceptable under the sales of goods act and other party can refuse to pay based on the non-ascertainment of the goods. It is also important to understand that under the sales of goods act, the respective rights and liabilities of seller and buyer will arise only and the bank will have no recourse to complete its obligations under the law. Mismatching in guarantee number There is a mismatching in the number of guarantee mentioned in the bank’s undertaking as well as in the Turhan’s assertion. According to the rules pertaining to the international trade and payments, it is important that the documents must contain the information which is correct and without any material differences. Though under the performance guarantee issued by the bank, bank is liable to honor its commitment however, it is critical to note that the conditions under which performance guarantee was issues shall also be met before guarantee can be invoked. As such it is critical that Turan must first evaluate and explore the conditions under which the performance guarantee was opened. If one of the conditions mentioned in the guarantee contained mentioned that the guarantee can only be enforced when all the conditions to the contract are fulfilled. Though this may not be considered as a material error however, it depends upon the bank also to accept whether the error is considered as material or not. If the error is not considered as material, bank may accept the claim based solely on this assuming that all the conditions to the contract and conditions stipulated in the guarantee are fulfilled. If the conditions are not fulfilled, bank holds the right to refuse to honor the performance guarantee issued. Letter of Credit In the second given condition, Turhan has basically refused to open the letter of credit in favor of Saida. If the opening of LC was one of the conditions for completion of the contract for sale, Turhan therefore is liable to Saida and Saida can refuse to sell the goods. This condition therefore is one of the general conditions under which one party failed to honor its commitments and under the sales of goods act, seller may not be liable to ship the goods as the buyer has not fulfilled one of the conditions to the contract. It is also important to note that the contract also does not specify any other type of payment arrangement in place of the letter of credit and as such Saida may not be liable under the contract because Turhan has failed to fulfill one of his commitments. It is also important to note that once a performance guarantee is issued by a bank or a financial institution, it may not be able to back out from its commitment if everything is in order and all the conditions to the issuance of guarantee are complied with. If the guarantee stipulated that it will only be invoked after the issuance of letter of credit by the Turhan than Turhan may not be able to invoke the guarantee and claim the compensation from the bank owing to the fact that Saida failed to perform the work. Saida on the other hand will also not be able to claim any compensation because goods were not shipped and the transaction was not actually executed in accordance with the different conditions to the contract. Q#2 It has been said that Islamic trade finance methods are little more than financial sleight-of-hand designed technically to comply with theological requirements governing the finance exercise while resulting in the same flow of capital as if a Western finance model were employed. Critically discuss how Islamic finance methods are used to finance the international sale and purchase of goods and to what extent, the above observation is justified. Ans# Islamic Finance is considered as an alternative to the modern way capitalism and its financial system as it tends to presents a relatively different and unique view about how to deal with finances. The key difference between the two is the relative degree of speculation and the allowing of activities which can involve risk and betting. Further, Islam discourages usury therefore the modern concept of the interest may not be directly applicable to the transactions conducted under the Islamic mode of financing. 9 One of the key aspects of the Islamic finance is that it discourages speculation therefore all activities whose outcome is based upon the chance are considered as banned under the laws of the Sharia. It is because of this reason that Islamic finance normally discourages activities such as short selling of the stocks because the buying and selling of something which is based purely on speculations is prohibited. The same ideology and philosophy has been carried forward in the international trade also wherein the available instruments actually prohibit any transactions between importers and exporters where speculations are involved. 10 However, despite this disparity with the modern financial system, Islamic finance has made its mark and has been able to develop into a discipline which can offer plausible alternatives to the modern way of banking and finance. Islamic finance is based on the Sharia and its major implications include ban on the interest or usury, parties to a business or transaction are required to adhere to the sharing of risks and profits, removal of any uncertainty when contracts are made, the backing of assets as well as promoting ethical investments which can contribute towards society. One of the most commonly used Islamic Finance product for conducting international sales and purchase transactions is called Murabaha. The literal meanings of the word Murabaha is the sell and purchased on the basis of mutually agreed profit rate between the parties or mark-up sales. Accordingly the overall sales takes place between three parties under which the actual buyer approach the financial institution to actually buy the goods from the seller and sell it back to the buyer. However, in order to avoid the administrative hurdles, financial institution nominates the actual buyer as the agent to purchase the goods on its behalf and settles the payments. One of the key aspects of such transaction is the fact that the seller has to disclose to the buyer the actual cost and than can add a certain percentage of profit. 11 The key difference in concluding the international trade transactions however, is in the opening of letter of credits wherein the supplier of the goods actually asks Islamic finance institution to open a letter of credit in his favor. As such technically the contract of sales actually takes place between the institution and the seller rather than between the seller and the actual buyer. Though apparently this may seem to be of same nature as in the modern international trade system where the bank assumes all the risks of the payments and opens a letter of credit with an undertaking that in case of failure by the buyer to pay, bank will pay to the seller. However, under the Islamic mode of financing, both the buyer as well as the bank are same therefore the overall risk is technically minimized because seller or supplier actually sales to the Islamic Finance Institution rather than the actual buyer. As discussed above, under this mode of financing, the importer acts as an agent of the Islamic Finance institution and undertakes to buy the goods after delivery from the bank at a certain mark-up over and above the cost price. Another important variant used in the international finance transactions is called Istisna which is same in its essential feature with the Murabaha however, technically it is relatively different. Under the Sharia, no sale can take place if the goods to be sold do not exist therefore in order to make a valid sales, it is important that the goods must exist in real before the agreement to sale can be executed. However, under Istisna and Salam, this condition is not necessary and the buyer and the seller can actually enter into contract for sale even if the commodity is not present in physical form. Salam is a kind of transaction under which a seller can actually undertake to provide certain type of goods or commodities in future against the payment made in full and in advance. The international trade transactions which are based on advance payment options therefore can easily be covered under this mode of financing and the firms which are ready to assume the risk of each other can actually use Salam as a mode of financing at the time of entering into the transaction. Under Salam, buyer will have to pay the entire amount in advance and the exporter will have to undertake to provide the specified goods in future date according to the price paid. 12 Istisna is also a relatively same kind of transaction under which both the importer and the exporter can enter into the transaction without actually the physical presence of the commodity. Under the Istisna, the commodity is not necessary to be manufactured however, both the seller as well as the buyer can enter into the sales agreement however, price needs to be fixed before the commodity is actually manufactured and transferred to the seller. Istisna is more important in terms of international trade and payments because Istisna can only come into existence if the goods are manufactured whereas the salam can be entered with any kind of commodity. As such Istisna transactions can only be concluded under the situations where the importer requires manufactured goods rather than any other type of commodity. The rest of the mechanics are almost same and does not deviate much specially in terms of international trade transactions. The above discussion therefore suggests that the overall impact on the essence of the transaction remains same whereas the overall mechanics are relatively different. Under the normal circumstances, when an exporter and importer enter into a contract and resultantly the letter of credit is issued, the risk still remains with the buyer to pay however, bank assumes such as risk. However, under the Islamic modes of financing the international trade, the bank also serve as a buyer through its agent therefore the overall risk is higher on the part of the bank if the customer fails to honor its commitment. As such the element of risk sharing is one of the key elements especially in the wake of the default by the customer. 13 It is also important to note that under Islamic mode of financing the international trade, the overall risk sharing occurs between the bank and the actual buyer however, the letter of credit is often issued by the bank on its own behalf. The sharing of the risk therefore is one of the key elements in the Islamic finance transactions. Banks and the buyer/borrower undertake to share the profits and losses arising as a result of the normal course of the business. This also means that the bank may also incur the losses and will have to share such losses under extreme situations.14 It is also quite possible that the international trade transactions can take place based on the twin contract basis. Under such arrangements two contracts are made wherein the bank and the exporter can enter into contract on cash basis whereas the bank and the importer can enter into the contract based on mark-up. The overall flow of capital however remains same whether an importer or exporter uses the traditional method of financing or Islamic Financing modes. Under both the modes, the buyer will have to assume same level of responsibility in terms of paying back to the bank. However, the key difference is that under the Islamic finance, goods are resold on the mark-up basis to the borrowers i.e. bank or Islamic financial institution actually purchase the goods from the international market, pay to the exporter and charge a relatively higher price to the buyer to claim its markup. It is pertinent to mention that the Islamic finance and its different applications are backed up a particular theology. The underlying dynamics of the instruments as well as their applicability therefore is largely result into same level of outcome as compared to the use of traditional methods of international trade. Issuance of letter of credit is done based on the rules outlined by ICC and other relevant international laws whereas the settlement between the issuing and advising banks is also done based on the use of traditional methods of finance. The resulting flow of the capital is also relatively the same as the funds move through the same channels and banks transact with each other as they would be transacted under the normal circumstances. The overall change between the Islamic finance and the traditional methods of finance however, can only be visible where the Islamic banks transact with each other and different channels for the settlement of funds could take place. In the absence of any alternative channels for the settlement of funds in Nostro as well as Vostro accounts therefore will only be done through the traditional channels of finance and therefore the overall difference may remain minimal. What distinguishes Islamic mode of financing the international trade is however, the way transactions are designed between the parties and the overall role of the banks. Under Islamic finance transactions, the overall role of bank becomes more significant as compared to traditional mode of financing. According to the UCP 600 rules, banks in international trade transactions only deal in documents however, under Islamic mode of financing, banks not only deals in documents but in goods also. This is the key difference when both of these methods are executed to conclude the transactions under the international trade. Though to some extent it may be said that the Islamic mode of financing the international trade is a trick of hand and is only done to comply with the theological requirements of Islam however, there are some critical differences in the way transactions and risks are shared under both the financing systems. Conclusion Islamic mode of financing is increasingly becoming more critically in the wake of the current financial crisis. Islamic finance is critical due to the fact that it discourages speculative activities and requires the backing of the investments with tangible assets. Such aspect of financing therefore makes the whole system less prone to the external shocks and make it more sustainable to withstand sever financial crisis. There are different instruments and methods used under the Islamic mode of financing to settle the international trade transactions. Murabaha and Musharka modes of financing can effectively offer the same level of comfort to the importers and exporters as they may enjoy by using the traditional methods of finance. However, the overall philosophical and theological structure of such transactions may not directly comply or correspond with the traditional modes of financing. Under both these transactions, bank actually enters into a contract with the exporter and opens the letter of credit in favor of the exporter on its own behalf. However, bank also simaltenousely enter into another agreement with the actual buyer for the resell of the same goods under the mark-up basis. Mark-up basis allow the banks to earn some level of profit by technically reselling the same goods to the importer at relatively higher price. It is also critical to note that under Murabaha and Musharka, physical presence of goods is necessary however, under Salam and Istisna transactions it is not necessary to have the commodities or products ready and the buyer as well as the seller can enter into the contract to supply the goods sometimes in future. however, the price consideration is paid at the time contract is made. It is therefore critical that the overall modus operandi of Islamic finance instruments may be different however; they result into the same level of capital flow. Bibliography 1. Ahmed, A. M., and El Tiby, A. M., Islamic Banking: How to Manage Risk and Improve Profitability. (John Wiley and Sons 2001.) 2. Ayub, M. , Understanding Islamic Finance. (John Wiley and Sons 2009) 3. Bishop, E, Finance of international trade (Butterworth-Heinemann, 2004). 4. El-Gamal, M. 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