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A
member of letterofcreditforum.com raised on the same forum a question
regarding the right to recourse in case the documents honoured or
negotiated are found to be discrepant or forged and rejected by the issuing
bank or applicant. The question is not new. Still, it has remained to be one
of the focuses of attention of LC practitioners in the world. As a banker,
I wish to share my view on the question as follows:
What
is recourse?
In the
context of documentary credit operations, recourse is normally understood as
the nominated bank’s right to recover from the beneficiary any payment or
advance that the nominated bank has made to the beneficiary in the event
reimbursement is not received from the issuing bank. That such a recourse is
available or not depends on the agreement between the nominated bank and the
beneficiary and/or the rules of UCP, i.e. the payment or advance has been
made on a with or without recourse basis.
Recourse in case the documents are discrepant and rejected by the issuing
bank
Unless
a nominated bank is the confirming bank, an authorization to honour or
negotiate does not impose any obligation on that nominated bank to honour or
negotiate, except when expressly agreed to by that nominated bank and so
communicated to the beneficiary (Art 12 (a) UCP 600).
In the
light of the above provision, a nominated non-confirming has its own option
to honour or negotiate the documents either with recourse or without
recourse. If a nominated non-confirming bank has agreed with the beneficiary
to honour or negotiate the documents with recourse and if reimbursement is
not received due to a correct refusal by the issuing bank, that nominated
bank will have recourse to the beneficiary. However, the nominated bank will
bear the risk of loss, i.e. not having recourse to the beneficiary, if it
has agreed to honour or negotiate the documents without recourse.
A
nominated confirming bank must honour or negotiate the documents without
recourse if the credit is available with the confirming bank (UCP 600 Art.
8). In view of this provision, a confirming bank will not have recourse to
the beneficiary once the documents honoured or negotiated by the nominated
confirming bank are found to contain discrepancies and rejected by the
issuing bank. However, in the scenario where the documents presented are
found by the confirming bank to contain discrepancies and the confirming
bank has agreed with the beneficiary to honour or negotiate under reserve,
i.e. on a with recourse basis, that confirming bank will have recourse to
the beneficiary if reimbursement is not received due to a correct refusal by
the issuing bank.
Recourse in case of fraud
The
famous court case between Banco Santander and Banque Paribas led to some
changes in UCP regarding the position of the nominated bank in case of
fraud. These changes are reflected in the following provisions:
UCP 600
Article 34 says: A
bank assumes no liability or responsibility for the form, sufficiency,
accuracy, genuineness, falsification or legal effect of any document …
UCP 600
Sub-article 12(b) says: By nominating a bank to
accept a draft or incur a deferred payment undertaking, an issuing bank
authorizes that nominated bank to prepay or purchase a draft accepted or a
deferred payment undertaking incurred by that nominated bank.
UCP 600
Sub-article 7(c) says: An issuing bank undertakes to reimburse a
nominated bank that has honoured or negotiated a complying presentation and
forwarded the documents to the issuing bank. Reimbursement for the amount of
a complying presentation under a credit available by acceptance or deferred
payment is due at maturity, whether or not the nominated bank prepaid or
purchased before maturity. An issuing bank's undertaking to reimburse a
nominated bank is independent of the issuing bank’s
undertaking to the
beneficiary.
Under
these new and/or revised provisions, the nominated bank that has acted on
its nomination is entitled to full reimbursement from the issuing bank even
in case the documents honoured or negotiated are found by the issuing bank
to be forged. Of course, the nominated bank must evidence that it has
honoured or negotiated the documents without recourse and it has checked the
documents with reasonable care and has not been aware of any sign of fraud.
My
above explanation about the position of the nominated bank in fraud cases is
mainly based on the new provisions of UCP. However, I wish to share Mr. T.O
Lee’s concern in his response to my query that these new provisions may not
be workable in the courts of law globally.
Let’s
take China as an example. The Supreme People’s Court promulgated The
Regulations of The Supreme People’s Court on Several Issues in the Hearing
of Cases Involving Disputes over Letters of Credit (entered into effect on
1st January 2006). According to these regulations, the Chinese courts will
not support a credit dispute regarding the underlying transaction between
the applicant and the beneficiary of the credit, except in the case of
fraud. According to Jia Hao’s explanation (in an interview by Kim
Christensen of lcviews.com), the provision (Articles 8) reflect the
well-established “fraud exception rule” in the letter of credit world. The
purpose of such fraud exception rule is to stop fraudsters from getting
benefits by use of letters of credit.
Regarding fraud exception rule, UCC Article 5 of the United States also
provides that a court may enjoin honour of a payment demand when a required
document presented under the letter of credit is forged or fraudulent or
where there is fraud in the transaction.
It is
largely understood that local law always prevails over rules including UCP
rules. In reality there is a practice that has been globally recognized:
where fraud is involved, the court is normally on the side of the defrauded.
Suppose that the issuing bank is obligated under UCP to reimburse the
nominated bank, the issuing bank will normally ask the applicant to deposit
funds (in case the import transaction is self-financed) or to provide signed
promissory note to the issuing bank (in case the import transaction is
financed by the issuing) to cover the payment. Thus, the issuing bank’s risk
is passed to the applicant. However, except where there is a collusion
between the applicant and the beneficiary like Solo Industries fraud case,
no applicant easily agrees to pay for the fraudulent documents. Most of
the time the applicant (maybe with the issuing bank’s consultancy) will seek
an order from the court to suspend the payment. And it is quite common that
local courts seem to be ready to issue such an order to protect the interest
of the applicant. Such an order will become much more forceful especially
when the nominated bank has honoured or negotiated the documents with
recourse. There is a bad habit in letter of credit operations that where
there is the court’s interference some nominated banks often claim they have
honoured or negotiated the documents without recourse while in fact they
have done with recourse.
China’s
above-mentioned regulations has no clear provisions on how the court should
deal with fraud cases where the nominated bank has honoured or negotiated
the documents without recourse, neither does the United States’ UCC Article
5. So far, it is too early to know how the courts of law globally will deal
with these cases. Perhaps we had better take a wait and see attitude towards
the matter.
Pending
the future responses from the courts of law to the related provisions in UCP
600, sharing the view of a member on letterofcreditforum.com, I think in
fraud cases the nominated bank should in the first place take legal action
against the beneficiary to get back the money if no reimbursement is
received from the issuing bank. It is more convenient and advantageous for
the nominated bank to have recourse to the beneficiary as the nominated bank
and the beneficiary are normally in the same country. And of course, I
believe no court supports the party who has committed a crime.
[October 2007]
A
comment by Bogdan Ilie: First of all I
think a nominated/confirming bank would ask for a legal written proof of the
fraud in which respect an issuing bank refuses the document (payment). Upon
receipt of such proof the nominated/confirming bank should indeed refund the
issuing bank immediately.
I think a nominated/confirming bank could stipulate
(in agreement concluded between it and the beneficiary) among other things,
that in case of any kind of fraud being proved under the LC, nominated/confirming
bank will debit the beneficiary in order to refund the issuing bank with
amount paid plus any interest, if claimed by the issuing bank.
The refuse to refund the issuing bank could
seriously affect nominated/confirming bank’s image/prestige. I don’t think
that a bank would take such a risk; no mater how important the beneficiary
is for to the bank. In the end is not a problem of rules – but one of
ethic.
The fact that a nominated/confirming bank had no
knowledge of the fraud at the time it checked the documents and paid,
doesn’t morally absolve that bank from the action it should take (of
refunding).
When and if the nominated/confirming bank get the
money back from the beneficiary is another problem and is not to be
discussed, as being an action that take place outside the LC.
Best regards,
Bogdan
[November 2007] |
