UCP600 comes into effect on 1 July 2007. With reference to English case law, critically evaluate and discuss whether UCP 500 has been successful or not.
Letters of Credit in International Trade
Letters of credit constitutes a financial scheme developed to govern large- scale international trade involving huge amounts of money[1]. This financial scheme generally involves a number of entities: buyer and seller; bank of the buyer and seller; and the carrier. After a contract of sale emerges between the buyer and seller, the buyer requests a letter of credit from the bank to give to the seller in order to commence the shipment of the goods. Upon receipt of the letter of credit, the seller consigns goods to the carrier in exchange for the bill of lading. In order to receive payment, the seller shows the bill of lading to its bank. The bank of the seller then takes the bill of lading to the bank of the buyer to receive the amount it paid to the seller. The bank of the buyer then shows the bill of lading to the buyer in order to receive the amount it paid to the seller’s bank. Upon receipt of the bill of lading in exchange for payment, the buyer shows this to the carrier as proof of the right to the goods delivered.[2]
Parties to the letters of credit constitute the beneficiary intended as recipient of the payment[3]. The bank issuing the letter of credit or the bank of the buyer is the ultimate beneficiary because when the bill of lading reaches the bank, it has the right to exchange the bill of lading for the amount contained in the document. The advising bank that is also the bank of the seller also becomes a beneficiary because upon receipt of the bill of lading and payment of the amount contained therein to the seller, it can claim the value paid to the issuing bank. This means that the applicant is not a party even if he catalysed the issuance of the letter of credit since the beneficiaries are the financial institutions involved in the financial scheme.
Letters of credit are also documents issued by financial institutions representing the agreement for payment that could either be revocable or irrevocable depending upon the agreement of the parties involved. As a document, letters of credit represents the agreement among financial institutions to pay the holder of the document.[4] This means that there is no need for the buyer and seller to meet personally and transact payment in cash. This offers convenience to international traders located in different countries.
Letters of credit work as source of payment for transactions so that the seller or exporter in international trade secures payment by showing the letter of credit. However, the guarantee works only in instances when the parties have complied with terms and conditions covered by the letter of credit. In international trade, guarantee of payment leads to rightful claim of payment as soon as the buyer made payment to the issuing bank so that all beneficiaries have been able to receive payment. When the beneficiaries have received payment, the buyer shows the bill of lading to achieve the release of the goods carried.
However, there are risks involved in letters of credit. First is credit risk that constitutes change in the credit of the opposing business. This means that a change in credit could affect the ability of the applicant to make payment upon the showing of the documents claiming payment. Second is exchange rate risk due to shifts in exchange rates. Changes in exchange rate could decrease or increase the value paid in a different currency. Third is force majeure risk that involves either risks brought about by natural disaster or impact of state policies on trade. Changes could affect the fulfilment of the terms and conditions of the letters of credit that in turn affects the application of the financial guarantee. Fourth are other risks such as deviations in legal application as well as language and cultural differences. This could cause delays in complying with the terms and conditions of the letters of credit that could in turn influence the guarantee of payment. [5]
These risks find cause from changes in domestic and international factors affecting the ability of the parties involved to meet the terms and conditions of the letters of credit when the parties come from different countries applying different trade laws and business policies and differing in economic situations. This makes the application of letters of credit complex and unclear because of the differences in the standards applied by the various financial institutions together with the varying factors affecting the operations of these financial institutions.
With the rise of international transactions using letters of credit amounting to one trillion in US dollars every year resulting to various risk issues, the International Chamber of Commerce (ICC) spearheaded the development of international standards governing letters of credit in order to facilitate the use of this financial scheme in international trade and smooth out transaction problems. In 1933, the ICC publicises the Uniform Customs and Practice for Documentary Credits (UCP) that constitutes the best practices developed by financial institutions engaged in letters of credit for long periods. The UCP has been revised and updated regularly with the UCP 500 constituting the latest version. This standard has been recognised and applied by 170 countries, indicating that these rules have found widespread following implying the enforceability of these rules in international customary law.[6]
Uniform Customs and Practice for Documentary Credits (UCP) 500
UCP 500 is made up of 49 articles under 7 chapters that cover various aspects of the engagement in letters of credit. The first chapter defines various terms used in the application or issuance of letters of credit to clarify the meaning and scope of these technical terms together with clarification of the application of the rules such as on letters of credit alone without covering the agreements underlying the engagement in letters of credit. Second chapter covers the types of credits and the corresponding obligations governing these credits since various credits emanate from various circumstances and give rise to different rights and obligations. Third chapter deals with liabilities and responsibilities of the parties involved in the application, issuances and implementation of letters of credit since there are requirements and procedural formalities required by the process. Fourth chapter deals with the documentary requirements of engaging in letters of credit such as the bill of lading, transport documents, and insurance documents covering the transportation of goods that underlies the application and issuance of the letter of credit. Fifth chapter involves the miscellaneous provisions covering the period covered by the guaranty of payment as well as instances when there is only partial compliance with the terms and conditions of the letters of credit. Sixth chapter covers the transferability and transference of credit. Seventh chapter discusses the assignment and validity of the assignment of proceeds receivable from the letter of credit.
On the surface, the inclusion of these various provisions shows that all aspects of the agreements, documents and processes are covered by the rules. This means that these should play an important role in governing international utilisation of letters of credit and find clear and simple utility as guide to financial institutions, traders and other parties interested or involved in letters of credit. However, revision of UCP 500 through the development of UCP 600 together with the cases in the UK covering the clarity and applicability of UCP provisions indicates that as much as the rules are important as international standards in the utilisation of letters of credit, there are a number of glitches needing change in order to address the issues of rule clarity and applicability. Thus the criteria for evaluating the success of UCP 500 lies in its ability to achieve the purpose for which it was developed, particularly provide clear guidelines in the determination of practical issues surrounding the engagement in letters of credit.
Strengths in the Clarity and Application of UCP 500
On one hand, provisions of UCP 500 clarify issues covering the engagement of people in letters of credit. The rules are able to determine the factors that should occur for UCP 500 to be explicitly or implicitly applicable to parties and situations involving letters of credit. Applicability of the rules are important since a number of cases reach the courts seeking the resolution of applicable rules in conflicting claims arising from the issuance or application of letters of credit. As rules that are recognised internationally in 70 countries, this has propelled UCP 500 to form part of customary international law with binding effect upon the parties whether the rules are expressly included in the terms and conditions of the letters of credit and/or impliedly applicable in the determination of rights and obligations arising among the parties involved in the letters of credit.
In British jurisdiction, there are a number of cases involving the applicability or non-applicability of UCP 500 rules and some rules were able to support successfully the determination of this issue. These cases were able to reinforce the importance of UCP 500 in letters of credit and clarify for the parties whether the determination of their rights and obligations should include the rules or pertinent national and international law together with contractual terms.
In v 7], Marconi Communications International is the manufacturer and seller of telephone equipment and engaged in a sales contract with PT Prismasentra Agung as the buyers of telephone equipment. The telephone equipment was sourced from the United Kingdom and the port of delivery is Singapore. Payment was arranged through letters of credit payable in 60 days, with the period commencing from the date of shipment. Hastin Bank issued the letter of credit to the buyer. Hastin Bank communicated the issuance of the letter of credit to SCB London, Marconi’s advising bank. SCB London informed Marconi of the issuance of the letter of credit. During the communications between Hastin Bank and SCB London, the latter inquired about the existence of a contract between the beneficiary and confirming bank and Hastin Bank responded that there is no such contract.
The implication of this answer is that the arrangement applies UCP 500 that provides for the separation of the letters of credit from the sales contract underlying the application of issuance of the letters of credit. In effect, Chapter 3 of UCP 500 governs the rights and obligations of the parties under the letters of credit. Based upon a reading of Chapter 3, two categories of rights and obligations arise. First category covers issues surrounding conformity with documentary requirements provided by the letters of credit for compliance by the issuing, confirming and negotiating banks. Second category involves the applicability of UCP 500 over disputes that may arise on issues of payment defined by the sales contract.
Upon receipt of the documents necessary to claim payment based on the letters of credit, Marconi presented documents to Panin Bank, since the financial institution acted as confirming bank to the letter of credit. Panin Bank received the documents and showed these to Hastin Bank. However, Hastin Bank refused to accept the document and make payment since there was an alleged failure of Marconi to comply with the documentary requirements of the letters of credit. Due to the failure of Panin Bank to comply with its obligation to make payment upon the presentation of the document, Marconi filed an action for breach of contract. The case was resolved with Indonesia as the proper jurisdiction for the claim of breach of contract.
Although, the claim of breach of contract was not settled, the case has important implications on the successful application of UCP provisions. First implication is on the applicability of the UCP provisions on sales or trade agreements. In the given case, Chapter 3 of UCP applied in determining the applicability of UCP provisions in the contract because in the communication between Hastin and SCB London, it was clarified that there was no contract between the confirming bank and beneficiary. Since there is no such contract, this is in line with the provisions of Chapter 3 that the letters of credit is separate from the contract of sale. In instances when there is no contract between the confirming bank and the beneficiary, provisions of UCP 500 applies concurrently with other applicable laws such as contract and commercial laws.
Second implication is on the applicability of UCP 500 in determining compliance with rights and obligations in instances when these are not covered by the agreement of the parties as well as in settling the applicable laws in case of conflicts arising between or among parties involved in the letters of credit. Since UCP 500 impliedly applies to the parties involved in the letters of credit, chapter 4 covering articles 20 to 38 applies in determining whether or not the claimant has duly complied with the documentary requirements necessary to support claims for payment. However, the determination of the existence of breach should be rightly determined by the Indonesian courts. This means that UCP 500 is successful in instances involving the determination of applicable rules in resolving issues arising from engagement in letters of credit.
v [8] covers the applicability of rights in instances when there is a dispute on the rights and obligations of parties in the letters of credit. A letter of credit was issued by Banque Paribas to Bayfern Limited on deferred payment covering 180 days following the bill of lading. The letter of credit was agreed upon to fall under the coverage of UCP 500 and the agreement that Paribas will pay Banco Santander as the confirming bank. In addition to agreeing as confirming bank, Santander also made the offer for possible discounting. Upon Bayfern’s request, Santander approved the discounting and credited the discounted amount on Bayfern’s account. Santander also requested Bayfern to provide a letter requesting the discounting together with an assignment of proceeds. Paribas was not informed of the discount or assignment. Since Santander made payment, it claimed the amount from Paribas. However, Paribas refused to make payment since it was not informed of the discount or payment before the expiration of the period agreed upon for claiming payment. In line with these facts, the banks raised the issue of the applicability of the UCP 500 in determining their rights and obligations.
The court held that UCP 500 has no application because of the invalidity of the assignment. The court held that there was no valid assignment of proceeds because Paribas was not informed of the discount and assignment. This means that Santandar has no right to claim reimbursement from Paribas for the discounted amount since this was not made on the direction or knowledge of Paribas. The invalidity of the assignment decried the existence of a relationship derived from the letters of credit that would support the application of UCP 500 rules. In this case, UCP does not apply because the rules apply only among parties who are rightful parties in the letters of credit. Since the assignment is not valid, a relationship as assignor and assignee did not exist so that no rights and obligations exists requiring governance by the rules.
This case provides the non-applicability of the UCP 500 such as in instances when no relationship between the parties that would result to the accrual of rights and obligations among the parties involved requiring governance.
Based on the two cases covering the applicability and non-applicability of UCP 500, this is successful in providing rules in determining whether the rules apply or do not apply in the resolution of certain issues. UCP 500 applies as governing rules in lieu of unclear or incomplete agreement terms relating to the letters of credit but does not apply in instances when a relationship that could have resulted to valid claims does not exist between the parties. In this sense, the rules successfully work in the resolution of rule applicability in the determination of rights and obligations.
Weaknesses in the Clarity and Application of UCP 500
On the other hand, existing provisions of UCP 500 also include provisional terms that are open to different interpretations. Terms open to various interpretations negate the clarity and applicability of the rules because instead of serving as guide in the determination of conflicting claims, these create conflicting understanding of the rules. Instead of supporting in the determination of cases, unclear words, phrases and provisions create court cases that require the courts to construe the meaning and intention of the rules.
A number of cases cover the differing interpretation of the rules resulting to cases that requires the resolution of the conflict by the courts. Some of these cases revolve around the interpretation and application of the doctrine of strict compliance in the documentary requirements of letters of credit. This doctrine has been explained by an English case decide in 1927, which provides that in strictly complying with documentary requirements of the letters of credit “there is no room for documents which are almost the same, or which will do just as well”[9] so that if banks do what they should do then it is safe from issues of non-compliance but if banks refuse to comply with its documentary obligations then it should be ready to incur risks. This doctrine is enshrined in the UCP 500 rules through article 4[10] that reminds the parties that in letters of credit they are dealing with documents and not goods or services. This means that the greatest concern should be the form and requirements of the documents instead of the contract of sale involving the transport or exchange of goods and provision of services. With the direction to look into the documentary compliance, the focus of the parties should not be diverted to other irrelevant concerns. Article 20 of UCP 500 also provides for the preparation of original documents as part of documentary compliance requirements.
In application, the doctrine of strict compliance implies that banks have the obligation to comply with their documentary obligations in observance of the doctrine of strict compliance since this applies in all transactions arising in the engagement in letters of credit such as the agreement between the banker and buyer, agreement between the seller and banker, and the agreement between the issuing and the correspondent banks. These documents should be original, with requirements of originality dependent upon the standards of international trade. These documents should not be carbon copied However, determining compliance is not as easy as it seems because the application of the doctrine gives rise to issues of interpretation or original complete documents.
Concurrently, article 13 of UCP 500 provides for the responsibility of banks to make close examination of documents they issue and receive to determine whether these documents are original and comply with form and content requirements. In trade, the bill of lading should duly support the letter of credit and other documents indicating agreement between banks should comply with the terms of the letters of credit. In case banks failed to comply with their responsibility to determine the originality and the face validity of documents, they should accept the risk involved in not receiving payment.
In v [11], the court decided the issue of the interpretation of the term ‘original’ as used in UCP 500. The court held that Article 20 should be the guide in determining the definition of original as documents complying with the requirements of the terms of the letters of credit. Other document copies purporting to be original may also be accepted as original as long as these are marked as original and signed as necessary. This means that if the documents are not copies but do not comply with the terms of the letters of credit or copies that are not marked as original or signed as needed, these are not deemed original. Documents complying with the letters of credit and copies marked as original, signed as needed, and compliant with the letters of credit are considered as original documents.
The case provides a means of applying UCP provisions covering the determination of original documents. However, the decision has been criticised as overly limiting the interpretation of originality. The purpose of article 20 under the UCP 500 rules is to provide a wide room for parties to determine original documents instead of limiting the means through which the parties can determine originality. The decision in this case resulted to the conservative manner of banks in considering the originality of documents. This resulted to a number of cases seeking court intervention in the determination of the originality of documents due to varying opinions between the claimant and banks. This also resulted to the practice of marking documents as original in order to allay questions of document originality.
The need for court intervention to determine the originality of documents means that article 20 of UCP 500 rules is not clear in itself to provide undisputed rules on original documents and tests of originality. These cases indicate that there is need to clarify terms of UCP 500 to provide clear and applicable interpretations.
In the succeeding case . v [12], the court clarified the decision in v [13]. The court provided that the actual intention of the ICC in including article 20 as rules is to widen the category for acceptable documents arising in the engagement of parties in letters of credit and not to narrow the categories. This means that banks are accorded by the UCP 500 rules with the responsibility to ascertain the originality of documents on its face and not in fact. As long as the document is examined to be original in its face, there is no need to go beyond this obligation and determine originality in fact. The exclusion only lies in instances when documents are reproduced through electronic means in the course of business of banks. In these types of documents, banks are provided the responsibility to investigate the validity of the documents to extend to the source of the documents to determine originality.
This case also indicates the need to change some terms of UCP 500 in order to clarify interpretation and application of these terms. These cases exemplify the weaknesses of UCP 500 that affects its success in providing clear terms on rules to follow in complying with the documentary requirements of letters of credit and obligations of the parties in complying with terms of the letters of credit.
Conclusion
UCP 500 is successful in providing implied terms in contracts arising from the issuance and application of letters of credit. The rules were able to prove salience in cases requiring the determination of the applicability of UCP 500 rules as exemplified in the two cases previously discussed. However, the rules also have weaknesses in the clarity and applicability of specific terms. In article 20 involving the criteria for determining original documents and the responsibility of the parties to investigate the originality of the documents on its face, this provision gave rise to different interpretations on the term ‘originality’ that required court intervention in construing the term. The need for court intervention to clarify the meaning of the term means that this is not clearly defined or used in the UCP rules to allow the parties in the letters of credit to agree on its meaning and prevent conflicting claims.
The UCP rules have repeatedly proven their significance in international trade as uniform and binding rules but it cannot be denied that there is also need to revise some terms in order to enhance the importance of the rules in providing clarity and applicability. This is the reason why UCP rules are continuously being revised and updated instead of repealed or replaced. With the UCP 600, it is hoped that the weaknesses of UCP 500 will be addressed to enhance the clear interpretation and application of its provisions.
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