A Critical Analysis of Article 5 of UCP 600 - Essay Example

?A Critical Analysis of Article 5 of UCP 600 Introduction The International Chamber of Commerce’s (ICC) Uniform Customs and Practice 600 (UCP 600) revised the practice rules relative to letters of credit in 2006 and thus replaced UCP 600 1993.1 Pursuant to Article 5 of UCP 600 cautions that banks do not deal with goods and services and are confined to dealing with documents.2 Therefore Article 5 of UCP 600 sets forth the rationale for the autonomous nature of the letter of credit and segregates if from the contract to which it relates.3 There are some problems that can arise from the autonomy of the letters of credit. More especially the fact that banks are not concerned with the terms of the contract to which it is attached, means that regardless of whether or not the goods are delivered or not or conform to the terms of the contract or not, the letter of credit must be honoured by the bank. This paper will analyse the consequences of Article 5 of UCP 600 and the potential for fraud and other forms of injustice to the parties impacted by a letter of credit. Letters of Credit In its simplest form, a letter of credit is a device by which a bank or other similar party agrees to provide credit to a specific party on behalf of another party upon receipt of the relevant supporting documents.4 A standard letter of credit is comprised of at least four parties: the vendor (exporter); the purchaser (importer) and each of their banks.5 The importer/purchaser’s bank typically issues the letter of credit which imposes a duty on the importer/purchaser’s bank to pay the specified sum to the vendor/exporter once the particularized documents are received.6 A key feature of the letter of credit is the fact that it is independent of the underlying contract to which it applies. In other words, the bank’s responsibilities under the letter of credit are segregated from any other contractual duties existing between the parties to the letter of credit. This would include contractual duties between the vendor and the purchaser or any duties on the part of “reimburse the bank for payments made” by virtue of the letter of credit.7 The banks involved in the letters of credit are typically referred to as the “issuing bank” and the “conforming bank”.8 The issuing bank is asked by the purchaser who is commonly referred to as the applicant to assume responsibility for paying the vendor who is commonly known as the beneficiary, a specified sum upon the presentation of specific documents. The conforming bank is the bank selected by the beneficiary that acts as a “correspondent of the issuing bank to advise the beneficiary on the terms of the credit” and usually assumes the “same liability towards the beneficiary as the issuing bank”.9 The autonomy of the letter of credit was fortified in the case of Gian Singh & Co. Ltd. v Banque de L’Indochine in which the court ruled that the autonomy doctrine obliges an insuring bank to make payment to the beneficiary even if the specified documents submitted by the beneficiary pursuant to the letter of credit were forged.10 It was also held in IE Contractors Limited v Lloyds Bank Plc that the duty of issue payment under a letter of credit is not conditional upon ascertaining whether or not the supporting documents presented by the beneficiary are correct.11 The autonomy of the letter of credit is justified in the grounds that contractual disputes occur quire frequently. It would therefore be obstructive to international trade to permit one party to use a contractual dispute to delay payment and thus the “assurance given to the beneficiary would be severely undermined” and thus “documentary guarantees would become unacceptable”.12 The autonomy principle of the letters of credit therefore illustrate that indeed, banks are only concerned with documents and not the underlying transaction to which it is attached. Although the rationale for the autonomy principle rests on limiting the risks of delaying or stopping payments in international trade, there are some concerns relative to the strict conforming principle implicit in the autonomy principle. For instance it appears to be contradictory to state that banks are only concerned with documents and not the underlying commercial transaction to which it attaches, yet, banks are obligated to honour a letter of credit even if the documents submitted are forged or incorrect. An examination of the UCP 600 sheds some light on the law relative to supporting documents aimed at reducing the incidents of forged or incorrect supporting documents. UCP 600 The ICC reported that when work commenced relative to the revision of UCP 500 in 2003, it was discovered that about 70% of the supporting documents submitted to issuing banks under a letter of credit were typically rejected when first submitted.13 The increasing number of first presentation rejections caused concerns relative to the authenticity of letters of credit as a feasible method for effecting international commercial trade, and thus, the revised UCP 600. The UCP 600 emphasizes that banks are not entitled to nor can they concern themselves with the underlying contract to which the letter of credit is attached. The point is articulated by virtue of Article 4 of UCP 600 which provides as follows: A credit by its nature is a separate transaction from the sale or other contract on which it may be based. Banks are in no way concerned with or bound by such contract, even if any reference whatsoever to it is included in the credit. Consequently, the undertaking or a bank to hounour, to negotiate or to fulfil any other obligation under the credit is not subject to claims or defences by the applicant resulting from its relationships with the issuing bank or the beneficiary.14 Moreover, a beneficiary is not permitted to refer to the contract between the conforming and issuing banks, nor the contracts between the applicant and the issuing bank.15 The issuing bank is also instructed to “discourage any attempt” on the part of the applicant to include the main contract as a significant “part of credit”, as well as copies of the contract, “proforma invoice and the like”.16 Thus UCP 600 makes a determined effort to establish and strengthen the autonomous role of the letter of credit and distancing it from the underlying contract to which it applies. Article 5 further buttresses the autonomy principle by providing that: Banks deal with documents and not with goods, services or performance to which the documents may relate.17 Article 14 is therefore prefaced by Articles 4 and 5 of UCP 600. Article 14 instructs that the issuing and confirming banks (where applicable) are only entitled to examine documents presented to them “on the basis of the documents alone” if the documents “appear on their face to constitute a complying presentation”.18 In other words, issuing banks are required to confine any inquiries relative to the documents supporting a letter of credit to the document itself. Article 14 elaborates by providing that any information contained in a supporting document “when read in context with the credit” there is no need to require that the information contained in that document be “identical to” information contained in the letter of credit.19 It is sufficient only for the information in the credit and information in a supporting document to not contradict one another.20 Moreover, all documents with the exception of the “commercial invoice” may describe the goods, services or performance obligations in “general” rather than contradictory terms.21 In other words, banks involved in the preparation and approval of a letter of credit are further distanced from the underlying contract and are not entitled to reject a letter of credit on the basis that it does not strictly reflect the particulars of the goods, services and performance obligations of the parties. It would appear that banks only need to be satisfied that the applicant wishes to make a payment to the beneficiary on the basis of a contractual obligation only briefly described. It would appear that the invoice is expected to provide sufficient information for the banks to act on. Documents that are not specified by the letter of credit, but provided nonetheless are required to be ignored.22 Therefore, even if a document is presented that proves fraud or some other injustice involved in the payment of funds under a letter of credit cannot be taken into consideration if that document was not specified under the letter of credit. In addition, in the event a letter of credit includes a term or condition and does not refer to a document indicative of adherence to the terms or conditions, banks are required to regard the term or condition as “not stated and will disregard it”.23 Essentially, Article 14 of UCP 600 departs from the “prescriptive” approach undertaken by UCP 500.24 Under Article 14 of UCP 600 banks have greater “flexibility” and the chances of rejecting non-conforming documents have been significantly reduced.25 Article 16 goes on to provide banks with instructions relative to how to respond when documents present discrepancies. Essentially, guided by the significant reduction in prescriptive approaches to determining documents comply with the letter of credit, a nominating or confirming bank who determines that the documents presented do not comply, banks may refuse to honour the letter of credit.26 However, issuing banks are at liberty to “approach the applicant for a waiver of the discrepancies”27 The degree of flexibility involved in UCP 600 for the purpose of reducing the risks of banks refusing to honour letters of credit have thus reduced the compliance mechanism to a great degree of ambiguity. Banks appear to have greater discretion and as such, uniformity may not be achieved. As Bergami explains, in today’s globalized economy, international traders require “certainty” and predictability with respect to identifying in advance what a bank might be expecting so that payment for services rendered or products transferred are made pursuant to the terms and conditions of the contract.28 Unfortunately, Article 5 of UCP 600 informs that the terms and conditions of the contract are not the bank’s concern. Article 5 of UCP 600 Article 5 of UCP 600 reinstates the notion that banks are not concerned with any obligations that the parties to the letter of credit may have to one another.29 Banks are to focus on the presumption that they only deal with documents and not involved in “goods, services or performance” related to the underlying contract.30 Banks are therefore not to concern themselves with the quantity or quality of goods, products, performances or services for which payment is made under the letter of credit. Banks are likewise not concerned with whether or not the goods or services have been delivered or will ever be delivered.31 The autonomy of the letters of credit was reiterated in the case of Maurice O’Meara v National Park Bank of New York in which it was established that letters of credit are separate and autonomous from the contract to which it is attached.32 This means that the bank issuing the letters of credit cannot renege on the letters of credit regardless of disputes relative to the quality of goods or services or failed delivery of goods or services under the underlying contract. The wronged parties remedy is against the other party to the contract. Thus, Article 5 of UCP 600 merely confirms a norm in international trade law. As Schaffer, Agusti and Earle observed, the case of Maurice O’Meara Co. has been accepted by American academics as a “classic statement of the legal nature of letters of credit and the independence principle”.33 Article 5 of UCP 600 can be said to reaffirm the autonomy of the letters of credit and thus the classic statement of its autonomy in the Maurice O’Meara Co. case. The injustices that may flow from the autonomy principle as enunciated in Article 5 of UCP 600 are aptly demonstrated in United City Merchants (Investments), Ltid. V Royal Bank of Canada; Regent Corp. U.S.A. v Azmat Bangladest, Ltd. [1982] 2 WLR 1039. In this case, the Royal Bank of Canada, the issuing bank had reason to suspect that the documents presented pursuant to the letters of credit were fraudulent. Thus the bank refused to honour the letters of credit. However, Lord Diplock stated that the bank is obliged to make good on the letters of credit if the documents “on their face” comply with the letter of credit: ...notwithstanding that the bank has knowledge that the seller at the time of presentation of the conforming documents is alleged by the buyer to have, and in fact has, already, committed a breach of his contract with the buyer for the sale of the goods, to which the documents appear on their fact to relate, that would have entitled the buyer to treat the contract of sale as rescinded and to reject the goods and refuse to pay the seller the purchase price.34 In other words, banks who are acting in the capacity of confirming banks are not allowed to refuse to honour payments pursuant to a letter of credit if those documents on their face, are consistent with the letter of credit. In this case, fraud had been committed by the shipper who sought to misrepresent the date of shipment of the goods so as to conform with the letters of credit. Thus pursuant to this ruling, the courts were powerless to enjoin a payment relative to fraud on the part of a third party effecting the authenticity of a letter of credit. Article 5 of the UCP 600 would therefore appear to enhance the opportunities for fraud by a third party to compromise the authenticity of a letter of credit. In a US case however, the court enjoined a payment under a letter of credit on the basis of fraud. In Szteign v J. Henry Schroder Banking Corp the plaintiff agree to purchase hog bristles from the defendant in India under a letter of credit. The defendant shipped miscellaneous items described as “worthless rubbish” to the plaintiff.35 Even so, the supporting documents reflected the shipment of hog bristles. The plaintiff filed a suit against the issuing bank seeking to enjoin payment pursuant to the letters of credit.36 The court articulated what is arguably the premise of Article 5 of UCP 600. The court stated that the purpose of the letter of credit is to ensure that vendors have a feasible means by which to receive payment promptly for services rendered or goods or products sold. In this regard: It would be a most unfortunate interference with business transactions if a bank before honouring drafts drawn upon it was obliged or even allowed to go behind the documents, at the request of the buyer and the seller into controversies between the buyer and the seller regarding the quality of the merchandise shipped.37 However, as the court noted, the operation of this guideline in the functioning of the autonomy of letters of credit presumes that the documents presented under the letters of credit are not only conforming, but also authentic.38 Even so, Article 5 of UCP 600 appears to take the position that this presumption for the most part may not be rebutted regardless of any knowledge that the bank may have or any evidence presented to the bank by the buyer or the seller that may rebut this presumption. As previously noted, Article 14 directs banks to ignore the submission of any documents not required to be submitted to the bank under the letter of credit. It would appear from the ruling in the case of Szteign v J. Henry Schroder Banking Corp. that only in the most egregious cases will the court enjoin payment under a letter of credit and thus permit banks to go beyond documents. The court ruled that in this case, the issue was not merely about a breach of warranty dispute between the vendor and the purchaser. This issue was more serious in that it involved the failure to ship the designated goods altogether. Thus the court ruled in the plaintiff’s failure and enjoined the payment under the letter of credit on the basis that the seller committed a deliberate fraud which was brought to the issuing bank’s attention.39 The case of Nareerux Import Co. v Canadian Imperial Bank of Commerce demonstrates that the seller can also suffer harm as a result of a bank going beyond the documents and thus emphasizes the significance of Article 5 of UCP 600. In the Nareerux case, the vendor shipped shrimp to the purchaser under a letter of credit under which the Canadian Imperial Bank of Commerce (CIBC) was the issuing bank. However, the issuing bank and the purchaser had relied on the proceeds from the sale of the shrimp dully delivered by the plaintiff to reduce the purchaser’s line of credit that had formed the subject of credit facilities by CIBC to cover the purchase of the shrimp from the plaintiff.40 As the court noted, one of the purposes of the operation of the letter of credit is to: Provide some measure of protection to a seller of goods that the seller will be paid in a timely fashion upon delivery of the goods to the buyer.41 However, in this case, the seller/plaintiff was left with no such protection and essentially lost with a shortfall of US$10.4 million despite having lived up to its obligation to ship the designated quantity and quality of shrimp.42 In this case, the concept of good faith was applied in that the vendor relied in good faith on the issuing bank who instead of issuing payment under the letter of credit, used the funds to discharge a loan by the purchaser. By taking this position, the issuing bank referred to the contractual relationship between itself and the purchaser, something that the letters of credit seek to avoid by maintaining its segregation from the underlying contract and the various relationships between the parties.43 It therefore follows that Article 5 of the UCP 600 is informed by past practices and the inequitable consequences that can result from banks and parties to the letter of credit going beyond documentary evidence. In the Nareerux case, the bank essentially operated in its own interest and was not concerned with the purpose of the letter of credit in international trade. It would therefore appear that Article 5 of UCP 600 is necessary to prevent conduct that may cause damages or losses to either the seller or the purchaser. However, the strict adherence to the face of the documents may not provide vendors and purchasers with sufficient protection. As seen in Szteign v J. Henry Schroder Banking Corp’s case, the damages may accrue to the purchaser outside of the presentation of the documents. In other words the documents on their face evidenced compliance with the terms and conditions for which funds were to be discharged under the letters of credit. However, only upon receipt of the shipment of goods did the purchaser discover that indeed goods described in the invoice and the supporting documents were not in conformity with the goods received. Conclusion Although Article 5 of UCP 600 intends to reduce the risks associated with delayed payments or stopped payments, it severely limits the application of equitable principles. By confining banks to documents and more importantly to the face of documents, banks are required to issue payments regardless of evidence existing outside of the documents revealing that payment or non-payment would be unjustified and in some cases cause irreparable harm to both the bank and the vendor or the purchaser. Regardless, UCP 600 is informed by years of practice and is designed to facilitate international trade in a timely manner. To this end it has been determined that authenticating the letters of credit is important for international trade which relies on the letters of credit as a means of facilitating commercial transactions across international borders. However, many questions arise as to whether or not the letters of credit can be adequately authenticated by ignoring the contractual relations between the issuing/confirming bank and the vendor or purchaser or the relationship between the vendors and purchasers. History as revealed in the cases studied in this paper informs that it may be impossible to authenticate the letters of credit by maintaining the autonomy of the letter of credit as provided for pursuant to Article 5 of UCP 600. It would appear that one risk was traded for another. More specifically, the risk of non-payment and delayed payments may have been traded for the risk of fraud which may not be discovered until it is too late or after one of the parties have suffered irreparable harm. Bibliography Textbooks Campbell, D. Remedies for International Sellers of Goods [2007] – Volume 3. (Salzburg, Austria: Yorkhill Law Publishing, 2007). Horowitz, D. Letters of Credit and Demand Guarantees: Defences to Payment. (Oxford, UK: Oxford University Press, 2010). Schaffer, R.; Agusti, F. and Earle, B. International Business Law and Its Environment. (Mason, OH: South-Western Cengage Learning, 2009). Journals/Articles Bergami, R.‘Will the UCP 600 Provide Solutions to Letter of Credit Transactions?’ (June 2007) 3(2) International Review of Business Research Papers, 41-53. Frias Garcia, R.L. ‘The Autonomy Principle of Letters of Credit’. (2010) III(1) Mexican Law Review, 67-96. Hsu, C. ‘The Independence of the Demand Guarantees, Performance Bonds and Standby Letters of Credit’. (2006) 1(2) National Taiwan University Law Review, 1-32. Mann, R.J. ‘The Role of Letters of Credit in Payment Transactions.’ (August 2000) 98 Michigan Law Review, 401-438. Wood, J. S. ‘Drafting Letters of Credit: Basic Issues Under Article 5 of the Uniform Commercial Code, UCP 600, and ISP98’. (February 2008) The Banking Law Journal, 103-149. Cases Gian Singh & Co. Ltd. v Banque de L’Indochine [1974] 2 All E.R. 754. IE Contractors Limited v Lloyds Bank Plc [1990] 2 Lloyd’s Rep. 496. Maurice O’Meara v National Park Bank of New York 146 N.E. 636 (1925). Nareerux Import Co. v Canadian Imperial Bank of Commerce [2009] O.J. NO. 4553. Szteign v J. Henry Schroder Banking Corp. 31 N.Y.S 2d 631 (1941). United City Merchants (Investments), Ltid. V Royal Bank of Canada; Regent Corp. U.S.A. v Azmat Bangladest, Ltd. [1982] 2 WLR 1039. Statutes Uniform Customs and Practice 600, 2007. Internet Sources Sebban, G. ‘UCP 600’, (n.d.) International Chamber of Commerce, 1-25, 2. http://alliedpetrol.com/Documents/ucp600.pdf (Retrieved 9 April, 2012). Read More