Banks, Business or Corporate Laws - Essay Example

? Banks Deal With Document Not With Goods, Services or Performance to Which the Documents May Relate (UCP 600, Article 5) of Institution] 4100 Words [Date] Introduction Commercial laws also referred to as business or corporate laws have been in existent since time immemorial and are applied in the regulation of both private and public commercial transactions. Covered in commercial laws are subjects and concepts such as merchant shipping, bills of exchange and partnership, principal, agent and insurance. Commercial law thus regulates commercial contracts, sales of products and hiring practices among other aspects of business. Bank regulations are just examples of the commercial laws that have received a considerable amount of attention in recent times (Grath, 2012, P. 124). These regulations are often established to ensure transparency between banks and individual clients and among the banks themselves. That is, banking regulations subject banks and their clients to certain guidelines and restrictions in the manner in which they conduct their businesses. The necessity of banking regulation, control and standardisation is emphasized by the interconnection the banking industry has with the other sectors of the economy. Banking regulations thus serve to lower or alleviate the risks that banks are exposed to and any disruptions and interruptions emanating from adverse economic and banking conditions (Grath, 2012, p. 45). Additionally, bank regulation reduces the criminal risks to which banks are exposed besides promoting and ensuring the confidentiality of banks (Miller & Gaylord, 2010, P. 46). This paper explores the statement that banks deal with document not with goods, services or performance to which the documents may relate, as stated in Article 5 of the UCP 600. This statement is explored in regard to the Letters of credit principles of autonomy, compliance principle and fraud, citing several case laws. The Letter of Credit and the UCP The importance of the letter of credit to the current commercial society is evidenced by the numerous rules established to regulate and control its use. Among these rules that regulate transactions involving the letter of credit is the UCP 600 (The 2007 Revision of Uniform Customs and Practice for Documentary Credits), prepared by International Chamber of Commerce’s (ICC) Commission on Banking Technique and Practice. The UCP 600 was approved by the ICC Commission on Banking Technique and Practice on October 25, 2006 but the rules became effective on July 1, 2007. The two unique articles included in the UCP 600 are Article 2 on “Definitions” and Article 3 on “Interpretations”, both aiming at improved clarity and precision in the rules. Prior to the 2007 version of the UCP, earlier versions appeared in 1933, 1951, 1962, 1974, 1983 and 1993. The prominence of UCP is evidenced in the current commercial environment by the many credit letters that are subjected to the latest version of UCP, UCP 600. Therefore, the credit letter is one of the many documents which banks deal with, instead of focusing on the use or performances with which the documents relate (Gutteridge & Megrah, 1985, P. 25). That a bank should deal with documents and not the use or performance to which these documents relate is statement contained in the Uniform Customs and Practices for Documentary Credits (the UCP), a set of rules targeting documentary credits in circumstance in which a credit is specifically indicated to be subject to the rules (Baker & Dolan, 2008, P. 93). The current version of the UCP rules, in use since July 2007, is referred to as UCP 600. The basic principle of documentary credit that outstands in Article 5 of the UCP is that ‘banks deal with documents and not with goods, services or performance to which the documents may relate, a statement reinforced by Article 14(h), which states that in situations in which a credit is attached to conditions that do not stipulate the documents for compliance to the condition, banks have the latitude to consider that condition not stated and thus should just disregard it (Baker & Dolan, 2008, P. 117). Nonetheless, it is commonplace to come across real-life credits with non-documentary conditions in which no documents are predetermined to be used to show compliance with the condition. The simple answer given in Article 14(h), advising that banks simply ignore the given condition may be wrong or insufficient to address this issue. The major problems relating to UCP in regard to these Articles is UCP’s contractual nature and the fact that UCP allows for its terms to be overridden as state in UCP Article 1. In this Article, it is stated that the UCP rules apply and are binding to all parties, except if expressly modified or excluded by the credit (Baker & Dolan, 2008, P. 212). Given the fact that the UCP is included in the credit by reference implies the ability of the credit’s express terms, particularly the non-documentary terms to modify the UCP rules. Case laws on the applicability of the UCP 600 abound. An example is the Banque de l’Indochine et de Suez SA versus J. H. Rayner (Mincing Lane) Ltd [1983] QB 711, which had a non-documentary provision. One of the terms under the section entitled ‘special conditions’ in the credit was that shipment was to be effected on a vessel of a member company of an International Shipping Conference. However, the credit did not stipulate documentary evidence that would show this condition was complied with. At first, Parker J insisted that it was the bank’s obligation to ensure the condition was met and given that banks deal with documents, the bank had to insist on reasonable documentary proof. In fact, the Court of Appeal affirmed this point of view in its judgment, read by Sir John Donaldson MR who stated that the condition was quite regrettable. Similarly, the condition did not favour the bank, which was also required to decide on the kind of documentation that would prove that the condition had been met. Luckily for the Banque de l’Indochine case, the condition was quite mild. There are cases with more serious conditions attached to credit. In these serious cases therefore, a banker may be compelled to know the work or performance to be financed by a credit. In fact, the Banque de l’Indochine case was addressed under the 1974 version of the UCP that never had the Articles 13(c) and 14(h). The other case involving letters of credit and compliance with non-documentary conditions is the Kumagai-Zenecon Construction Pte Ltd versus Arab Bank Plc [1997] 2 SLR. 805: [1997] 3 SLR 770. In this case, the defendant bank issued a standby letter of credit in which the UCP 600 was referenced. The purpose of the letter of credit was to obtain payment for the applicant’s judgment debt. As a consequence of earlier judicial proceedings, the applicant was to buy certain shares at a fair price, to be fixed by autonomous valuers (Katz, 2008, P. 65). Although some documents were stipulated in the letter of credit, the valuer’s report was not. On making a demand against the letter of credit, the beneficiary produced the expressly stipulated documents but not the valuer’s report. To this action by the beneficiary, the defendant bank refused to pay, stating that the terms and conditions of the credit were not complied with wholly. Fortunately for the bank, the trial court and the Court of Appeal first upheld the bank’s action of dishonouring the credit, citing the credit’s inconsistence with the terms of the UCP 600 (Katz, 2008, P. 69). To solve the stalemate, the courts resorted to the principle of contracts that expressed terms override those incorporated by reference to the UCP 500. Similarly argued like the Kumagai-Zenecon Construction Pte Ltd versus Arab Bank Plc [1997] 2 SLR. 805; [1997] 3 SLR 770 case was the Korea Exchange Bank versus Standard Chartered Bank [2006] 1 SLR 565 in which a similar reasoning was adopted, albeit with a slight twist. In the judgment, Andrew Ang J asserted that Article 13(c) of the UCP 500 was to established to address the tendency of issuing banks place non-documentary conditions on letters of credit, concluding that negotiating banks against issuing banks. However, he also noted that Article 13(c) could also be effective against credit applicants. The Current Situation of the UCP 600 and other Credit Laws In the contemporary commercial environment, the status of the credit law could be described as uncertain. Banks are particularly left in a predicament by the “referenced terms versus expressed terms” debates currently going on. In fact, while the courts and contract lawyers continue to debate on expressed and referenced terms and conditions in letters of credit, banks are faced with the dilemma of accepting the presentation of documents or rejecting the presentation of the unspecified documents purporting to show compliance with credit conditions. The wording and intentions of the above quoted articles of the UCP are quite unambiguous and the intention of the International Chamber of Commerce in changing the UCP to ban non-documentary conditions in credits is equally clear (Katz, 2008, P. 71). Therefore, credits should be treated a special kinds of contracts in commercial interactions, implying that non-documentary conditions should be ignored. Regarding interpretation rules, non-documentary conditions are not expressly consistent with the terms of the UCP. Thus, rather than taking the assumption that non-documentary conditions contradict Articles 13(c) and 14(h) of the UCP 500, the articles should be regarded as providing the leeway for the interpretation of non-documentary conditions (Byrne, 2007). The line of argument in this case is that the parties to a credit may not intend any documentation for non-documentary conditions since Article 13(c) and Article 14(h) expressly implies that the negotiating banks would ignore such conditions. The above cited articles of the UCP therefore confirm that a credit is a separate commercial transaction from any other sale or contract with which it may be related. As a matter of fact, no changes have occurred to this assertion, even with the many versions of UCP established so far. In all these versions of the UCP, a letter of credit is not a contract from which a third party could benefit (Byrne, 2007, P. 42). That is to say, under no circumstances should a third party beneficiary present himself or herself for credit letter benefits, citing any relationship with either the applicant or the issuing bank as the ground for payment. Although Article 5 of the UCP 600 emphasizes the principles of Article 4 of the UCP 500 with modifications such as: "Banks deal with documents and not with goods, services or performance to which the documents may relate." The UCP 600 omits the statement that this statement applies to "all parties concerned" (Byrne, 2007, P. 90). Legal Principles of Documentary Credits One of the most outstanding principles of documentary letter of credit transactions is that the banks’ obligation to execute payment is autonomous of any underlying contracts of sale or any other transactions for that matter. That is, the terms of the credit alone define a bank’s obligations on a letter of credit. Similarly, any defenses from the buyer related to other contracts outside the credit terms are not the concern of the issuing banks and never affects the banks’ liabilities. Following similar assertions to this regard in Articles 4(a) and Article 5 the UCP 600 that banks are not interested in or concerned with the goods or use to which a document is placed, provided the documents presented by a credit beneficiary or his/her agent are in order, banks are obliged to pay without demanding any further qualifications. The major policies and ideologies of the autonomy principle are solely commercial and relate to the commercial expectations of the parties to a letter of credit. To start with, placing the responsibility for validity of documents on banks would overburden them since they would have to carry out investigations on the fundamental facts of each transaction (Enonchong, 2011, P. 57). These burdens would discourage banks from issuing documentary credits due to the risks and inconveniences therein. Credit autonomy also stems from the fact that relating credit to other transactions such as sales implies different documents would be required, presenting banks with the dilemma of which documents’ terms to follow. Once a letter of credit, which is an agreement between parties for one to pay a repayable amount of money to another, is completed, it is binding to the party meant to extend credit to the other (Enonchong, 2011, P. 62). With all its elements valid just like in other commercial contracts, the courts will always uphold the validity and the performance of a letter of credit. A letter of credit thus implies a contract is in place. An exception to the autonomy and validity of the letter of credit is the occurrence of a fraudulent act or information given to the creditor (Enonchong, 2011, P. 64). Should the person lending the money realize that wrong information was given, he/she should fulfill the fraud exception to annul the letter of credit, a principle preserved in the principles of UK common law. The other vital principle of the letter of credit is that of strict compliance. The compliance principle ensures that the concerned banks have adequate ease while executing its responsibility of effecting payment against credit documents. Additionally, the compliance principle ensures that such payments are effected quickly and efficiently. Effectively, if the language and content of the presented documents are not in line with those of the credit, the concerned bank is empowered to withhold payment even in cases where the identified deviations are terminological in nature. Relevant Bank Case Laws Among the cases in which banks have greatly relied on and benefitted from documents include those related to the autonomy principle, bank fraud and the compliance principle. The autonomy principle however affects central banks most since in most countries, central banks are quite autonomous. The autonomy principle also applies to certain banking documents such as the letter of credit. As result of the autonomy of the letter of credit, debates have come up on the impact of illegality as a distinct exception to the autonomy principle of letters of credit. It has since been established and agreed by many jurisdictions that fraud is an exception to the autonomy principle of the letter of credit. Fraud, a banking crime that has widely spread in recent times is generally regarded as an illegal contract. Nevertheless, the definition of illegal contracts in the banking sector is rather diverse and fraud is one among the many forms of illegal contracts in banking. In line with the principle of autonomy, illegality refers to contracts or deals that are contrary to a given statutory or common law position. The three basic requirements for a contract to be legally binding are agreement, intention and consideration. It is therefore quite of the essence that one understands these elements before agreeing on and signing a credit contract. Case Study the Fraud Exception in the UK and the US As mentioned earlier, fraud is one instance in which the autonomy of the letter of credit from a bank or other financial institution may be rendered void. Case studies of fraud exception abound in the UK as well as the United States and other countries. For instance, in the United City Merchants versus Royal Bank of Canada case, Lord Denning defined the fraud exception in a similar manner to the US Case of Sztejn versus Henry Schroder Banking Corporation. According to these two cases, it was opined by the courts that an exception to the principle of autonomy occurs whenever a seller, while drawing on a credit, fraudulently expresses or implicates representations that to his/her knowledge are false (Aikaterini-Lamprini, 2008, P. 118). Although leading landmark cases on the fraud exception to bank autonomy such as the Sztejn versus Henry Schroder Banking Corporation (1941) 31 N.Y.S. 2d 631 abound in the U.S., such cases are quite rare, if any, in the UK. For the courts to be allowed to interfere in cases involving the bank autonomy principle, the available evidences or burden of proof must reach a certain threshold and actually implicate and involve the beneficiary to a fraud (Aikaterini-Lamprini, 2008, P. 97). That is, there has to be an unambiguous proof that fraud has actually been committed for the courts to interfere. Otherwise, the merchants are left to deal with their disputes according to the dictates of their contract as applied in the case of Harbottle R. D. versus Natwest. Arbitration and litigation are two of the mechanisms by which disputing merchants may solve such cases involving the autonomy principle. The huge burden of proof that the UK courts place on the need to prove fraud has negatively affected the handling of banking autonomy cases, making UK’s approach to autonomy cases ineffective and unusable. Moreover, the requirement by UK courts that the fraud in question must have been committed by the beneficiary also renders the country’s approach to autonomy cases rather unusable (Aikaterini-Lamprini, 2008, P. 213). For instance, a third party may commit a fraud in a letter of credit, implying that the creditor must bear the weight of the fraud, even if it is proved beyond reasonable doubt that fraud actually exists. The United City Merchants case is an example of the many cases in which the third party scenario presented itself. From this case and the decisions upheld, it is clear that UK’s judicial system is more interested in adhering to contract certainty than it is in upholding the basic principles of justice, which uphold the notion of utmost good faith above that of contract certainty. Contrary to the case of the United Kingdom, the United States actually supports the fraud exception rule in addressing fraudulent actions by bank and other institutions’ clients and partners (Aikaterini-Lamprini, 2008, P. 39). The autonomy approach taken by the US is rather flexible and it epitomizes US’s strict adherence to justice contracts as seen in the case of United Bank Ltd versus Cambridge Sporting Goods Corporation. Cases on the Compliance Principle The second principle of banking in which banks have exploited documentation is the compliance principle. According to this principle, which was released in a document entitled ‘Compliance and the Compliance Function in banks,’ certain high-level standards and rules have been set for the management of compliance risks in banks. The Basel Committee on Banking Supervision established an accounting task force to evaluate the extent to which the compliance principle has been implemented. Additionally, the committee was directed to carry out a review of compliance-related cases, incidents and challenges facing the banking industry (Xiang, 2003, P. 156). . In the United Kingdom, there are company laws that hold that companies’ clients and other people/entities transacting business with banks assume that internal rules laid down by the banks are complied with. In fact, this law is often referred to as the ‘indoor management rule’ or the ‘Rule in Turquand’s Case’ and is applied in many countries as a common law. The law is named after the Royal British Bank versus Turquand Case (1856) 6 E&B 327 heard in the Court of Exchequer before the sitting judge Lord Jervis CJ. Although initially used to alleviate the harshness of the constructive notice doctrine, the ‘Rule in Turquand’s Case’ now receives support from sections 39-41 of the Companies Act 2006. Mr. Turquand was the liquidator-manager of the insolvent Cameron’s Coalbrook Steam, Coal, and Swansea and London Railway Company, which had given a bond for ?2000 to the Royal British Bank. Consequent to the bond, the Bank secured the company’s drawings on its current account. Although the bond was under the company’s seal and signed by two of its managers, on being sued, the company argued that under its articles of association, the directors could only borrow what was authorized by the company and an earlier resolution did not specify the amount the directors could borrow. At the Court of Exchequer, Sir John Jervis CJ affirmed the decision of the Queen’s Bench, asserting that the Royal British Bank was deemed to be aware that the company’s directors were only allowed to borrow up to the limits set by the company’s resolutions. According to the Court of Exchequer, the bank could put into effect the terms of the bond. In other words, the bond was a valid one since there was no requirement for the bank to look into the internal affairs of the company and it was also imperative on the bank to be aware of the ordinary resolutions passed in the company’s dealings. Those who concurred with the decision include Justices Cresswell, Crowder, Pollock CB and Bramwell B. The United Bank Ltd versus Cambridge Sporting Goods Corporation Case 49 A.D.2d 868 (1975) is the other case touching on the principles of the letter of credit. The respondent in this case was the United Bank Limited and others while the appellant was Cambridge Sporting Goods Corporation. The case appeared before the Appellate Division of the Supreme Court of the State of New York, First Department on October 30, 1975. In this case, the court established that the petitioners established, at first sight, the right to the earnings of the irrevocable letter of credit, with the respondent not being in a position to build a strong defense. Given that the respondent did not deny the genuineness of the signatures on the letter of credit, the said signatures were deemed admitted. Therefore, unless the defendant established a strong and convincing defense, the holders of the letter of credit, the petitioners, were entitled to recover on them. As earlier stated, the defendant had failed to provide reasonable proof that the petitioners had been fraudulent in any action or omission that could preclude them from recovering on the letter of credit. The fact that the original vendor, Duke Sports may have misrepresented, breached a warranty or committed fraud notwithstanding, these acts were not connected to the petitioners in any way. The Sztejn versus J. Henry Schroder Banking Corporation et al. 177 Misc. 719, 31 N.Y.S.2d 631 is the other case involving the principle of autonomy. In this case, Chester Charles Sztejn sought action against the J. Henry Schroder Banking Corporation and others to hold back the payment or presentation for payment of drafts. The defendant, Transea traders Ltd of Lucknow, India was contracted by the plaintiff to purchase some quantity of bristles. The plaintiff and his co-adventurer Schwarz contracted the defendant J. Henry Schroder Banking Corporation to issue an irrevocable letter of credit to Transea. According to the contract, a specified portion of the shipment would be paid by the Schroder Corporation upon the presentation of a bill of lading covering the shipment and an invoice. Schroeder’s corresponding bank in India delivered the letter of credit to Transea, which then placed the material on board after acquiring the relevant documents such as a bill of lading and other customary invoices. The complaint was that Transea had filled the fifty crates with cowhair and other worthless materials instead of the genuine merchandise, thus defrauding the plaintiff and his co-adventurer. Transea then allegedly drew a draft under the letter of credit to the order of the Chartered Bank and delivered the draft and the fraudulent documents to the “Chartered Bank at Cawnpore, India, for collection for its account. Consequently, Sztejn sought for a judgment declaring the letter of credit and drafts unacceptable and invalid. On motion by defendant the Chartered Bank of India, Australia and China to dismiss the supplemental complaint. Both motions were denied. Conclusion Surveys have indicated that approximately 60%-70% of all the letters of credit are rejected by the issuing banks at the initial presentation of the relevant documents. These worrying trends have caused concerns and anxiety at the domestic and international commercial levels. While some of these rejections could be based on genuine discrepancies in the presentation documents and other requirements of the letters of credit, other rejections are related to personal opinions, typographical errors and the varying degrees of expertise among practitioners. These findings hint at the need for far-reaching reforms since the identified rejections hinder and slow down local and international commerce besides the much costly litigation. The first to be reformed should be the courts, which should be competent enough to identify the discrepancies that constitute substantive grounds for the rejection of a letter of credit. In fact, there are certain minor discrepancies for which letters of credit should not be dishonoured. The central and vital role played by the letter of credit in the facilitation of domestic and international commerce makes it necessary that transactions dealing with the letter of credit are undertaken as flawlessly and expeditiously as possible. Thus, all the laws targeting the letter of credit should evolve as the world becomes more globalised, accompanied by changes demands and conditions in marketplaces. There is need for the establishment of more effective authoritative and legislative bodies to ensure the practical and commercial viability and usability of the letter of credit in regard to its main principles of autonomy and compliance. References Aikaterini-Lamprini, Z. (2008) The fraud exception to the principle of autonomy in the letters of credit: a comparison between british and american law. Amazon Digital Services. Baker, W., and Dolan, J. (2008) Users’ handbook for documentary credits under UCP600. Publication number 694. Paris: International Chamber of Commerce. Buddy, B. (2011) Operations Management Best Practice: Understanding the UCP600. Retrieved on March 14, 2012 from http://www.qfinance.com/operations-management-best-practice/understanding-the-ucp600?page=1. Byrne, J. E. (2007) The comparison of UCP600 & UCP500. Montgomery Village, MD: Institute of International Banking Law & Practice. Enonchong, N. (2011) The independence principle of letters of credit and demand guarantees, first edition. Oxford University Press. Grath, A. (2012) The handbook of international trade and finance: the complete guide to risk management, international payments and currency management, bonds and guarantees, credit insurance and trade finance, second edition. Kogan Page. Gutteridge, H. C., and Megrah, M. (1985) The law of bankers’ commercial credits, seventh edition. London: Europa. Katz, R. (2008) Insights into UCP600-collected articles from DCI 2003 to 2008. Publication number 682. Paris: International Chamber of Commerce. Miller, R. L., and Gaylord, A. J. (2010) Cengage advantage books: fundamentals of business law: summarized cases. Cengage. Xiang, G. (2003) The fraud rule in the law of letters of credit: a comparative study (global trade & finance series), first edition. Springer. Read More