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Post-communism period -
the beginning of LC Banking and LC-based Trade
After the transformation from the communist regime, Hungary set out on the
path leading towards the adaptation to open market economy. In the beginning,
the European Bank for Reconstruction and Development (EBRD) was instrumental
in this process. The EBRD cooperated with local experts in the preparation
of investment-friendly laws and commercially oriented policies. The efforts
resulted in the modernization of the law on personal property security that
was structured to revitalize local lending activities. The 1996 amendment of
the Civil Code was one of the first reforms of collateral laws in that
region. The EBRD also supported other trade-related programs and involvement
of Hungarian banks in various cross-border financial projects. Along with
the World Bank’s International Finance Corporation, the EBRD undertook to
guarantee LCs and bank guarantees issued by the banks operating in the
region.[1] These programs were structured to import the banking expertise
into the developing markets and establish the local banks’ reputation as
reliable partners.
The success of EBRD programs in the Visegrad countries (The Czech Republic,
Hungary, Poland and Slovakia) was in stark contrast with the slow
development of the southern part of Europe (Romania, Bulgaria, etc.). The
contrasting pace of economic development resulted in the faster accession of
the former group to the EU, whereas the southern part has been left out for
now.
Integration to the European Union
(EU) and Europeanization of the Hungarian Law
The recent Hungarian accession to the European Union
significantly impacted many areas of law and economy, including the banking
sector. Numerous EU Directives that regulate banking and other commercial
services have been transposed into the local law of Hungary and other
newly-admitted members. From the standpoint of LC practitioners, one of the
recent objectives, following the policy of other EU countries, is the
implementation of Basel II and the EU Capital Requirement Directive (CRD).[2]
The European Commission proposed CRD in 14 July 2004. It will be applicable
to all banks and investment firms within the European Union, once it is
approved by the Council. The approval is expected in the spring 2006 and the
Directive should be officially transposed into the laws of EU member states
sometimes during 2008. Other laws, such as the Credit Institutions Act that
regulates depositary institutions had to be amended as well.
Hungary is also following the reforms recently
undertaken in other neighboring countries. The goal of these reforms is to
improve the investment infrastructure and lending markets. Whereas the
former is designed to attract foreign investment, the latter stimulates
local commercial activities. To this end, Hungary has reformed its Civil and
Bankruptcy Code, which introduced numerous important creditor-friendly
provisions.
According to the report published by the
Hungarian Financial Supervisory Authority: “In 2005, the banking sector
increased at a rate even more dynamic than expected. With soaring foreign
exchange lending, the growth rate in the combined balance sheet total of the
sector surpassed the similarly remarkable development of the preceding year,
as it was 18% higher at the end of 2005 than a year before.”[3]
Hungarian LC law Infrastructure
A general review and modernization of the rules
governing the payments system has been on the agenda since 2003.[4]
Unlike its neighbors, Slovakia and the Czech Republic, Hungary does not
regulate letters of credit in the primary source of law, which would be
either the Commercial or the Civil Code. The Hungarian regulation may be
found in the Decree No. 6/97 that was issued by the president of the Federal
Reserve Bank. The Decree comprehensively governs credit transactions.[5]
With respect to the LCs, it only regulates few aspects and many crucial
issues have been left unaddressed. The terse regulation of LCs is in line
with the policy of other countries that scarcely enact laws on letters of
credit or absolutely neglect this area of law. This has proven to be a
better approach, since the vast majority of LCs is issued subject to the
internationally accepted banking practices incorporated in the UCP. To this
end, the Hungarian Decree also defers to the UCP with respect to the issues
that are not expressly covered therein.[6]
With the exception of this “UCP enabling provision”,
the rules of the Decree may be divided into two groups. First, which
consists of the initial four subsections, covers transactional aspects that
are related to the banking practice. The latter (last two subsections) is
tailored to address issues of banking governance and administration. These
two subsections allow the banks to set the monetary limit to which they will
accept applications for the issue of LCs. The regulatory limits are
irrelevant from the standpoint of document checker and belong to the
internal procedures of banks. On the contrary, the former group of rules is
more interesting for the LC practitioners and other involved parties.
Under the Hungarian law, similarly to the UCP and
other national laws, the LC mechanism comes to life when the applicant and
the bank agree on the issue of the LC. This bargain is traditionally
documented in the reimbursement agreement. By virtue of this agreement, the
applicant undertakes to reimburse the bank for the amount of the LC paid out
to the beneficiary.[7]
The Hungarian law respects the cornerstone rule of the LC business, which is
the independent nature of the bank’s promise from other arrangements,
including the above-mentioned reimbursement agreement.[8]
The bank’s obligation to pay “in its own name” the
amount of the credit is conditioned on the presentation of compliant
documents within the stipulated period.[9]
This rule raises several issues. First of all, the Decree seems to be
limited to only one type of LC- the payment at sight credit.[10]
The Decree neither provides for deferred payment undertakings nor credits
that involve drafts. In this aspect, the parties should invoke the “UCP
enabling provision” and accordingly structure their undertakings should they
prefer a deferred payment or presentation of drafts. Secondly, the bank’s
obligation is triggered upon the presentation of compliant documents. The
Decree does not prescribe the standard of compliance, whether it be strict,
reasonable or substantial. By virtue of the UCP enabling provision, the
standard incorporated in the UCP and ISBP should be applied by the local
courts if they found themselves in the position to decide on the issue of (non)complying
documents. Third, the bank and the applicant may agree on the period within
which the beneficiary must present the documents, according to the Hungarian
law. If the credit was issued under this law, the 7 day UCP banking period
may be altered by the parties. Shortening or increasing the period for
examination of documents creates uncertainty and unpredictability in the
financial markets. This is in contrast with the policy that promotes
finality of commercial promises and payments. Nevertheless, intra-Hungarian
LCs may be issued with various time limits for examination. Finally, the
Decree does not require compliance with other terms and conditions of the
LCs. In this aspect it deviates from the UCP 500.[11]
The limited scope of the Decree is also implied
in the beneficiaries’ requirement to present the documents directly to the
issuing bank.[12] The
Decree neither covers scenarios whereby the credit may be confirmed, advised
by some other banks, nor drafts and documents negotiated at the counters of
the bank other than the issuing bank. The availability of credit is thus
severely restricted under the Decree.
The Decree does not cover other important issues,
such as assignments, transfers or rules on the checking of documents. Its
limited scope is not particularly attractive for practitioners and other
credit users. These parties are advised to resort to UCP and other customary
sources (e.g. ISP98, U.R.D.G., etc.). The loopholes in the Hungarian law is
another proof that mercantile specialties, such as letters of credit, are
more adequately regulated in customary sources of law that reflect practice
rather than a legislative policy.
Financial services, other then LCs and bank
guarantees are also gaining on importance in this region. For instance,
reports show that factoring is becoming an important financing device in the
eastern European markets, including Hungary.[13]
The review of cross-border cases related to the
International Convention for the Sale of Goods (Vienna Sales Convention)
revealed one case decided by the Hungarian Metropolitan Court that touches
upon the issue of LCs.[14]
In this case, a Hungarian bank issued a letter of credit in favor of a
German beneficiary who sold timber machinery to a Hungarian buyer. The
abstract of the case did not indicate the rules that the credit was issued
subject to. The issuing bank located in Hungary dishonored the credit on the
basis of discrepant documents. After the beneficiary cured the discrepancies
and re-presented the documents, the bank refused to honor due to the
expiration of the LC. Rather then disputing the righteousness of the bank’s
dishonor, the German seller decided to take an action against the buyers.
The seller invoked remedies granted to him under the Vienna Sales Convention.
If nothing else, this case implicitly upheld the independence of the letter
of credit from the underlying sale contract and affirmed the dichotomy of
the seller’s/beneficiary’s remedies. Even if the bank dishonors the LC on
legitimate basis, the seller may still look into the sale contract for an
appropriate remedy against the buyer.
[1] For more information see Kevin
Godier, Risks in Eastern European Trade Finance, DCInsight Volume 2 No 4
Autumn 1996, Kevin Godier, Yugoslav War, Russian Debt Plague Eastern Europe,
DCInsight Volume 5 No 3 Summer 1999, Kevin Godier, Multilateral Banks Boost
Trade Finance, DCInsight Volume 6 No 3 Summer 2000.
[2] Hungarian Banking Association,
Report on 2004 Activities of the Hungarian Banking Association, p. 6 (March
2005).
[3] Hungarian Banking Association, E-Newsletter, April 12,
2006.
[4] Hungarian Banking Association, Report on 2004 Activities
of the Hungarian Banking Association, p. 18 (March 2005).
[5] Rolf A. Schutze & Gabriele Fontane, Documentary Credit
Law throughout the world, p. 76 (ICC 2001).
[6] Decree No. 6/97 at § 14(5).
[7] Decree No. 6/97 at § 14(4).
[8] Decree No. 6/97 at § 14(1).
[9] Decree No. 6/97 at § 14(1).
[10] UCP 500, at art. 9(a)(i).
[11] UCP 500, at art. 9(a).
[12] Decree No. 6/97 at § 14(2).
[13] Mark Ford, Alternatives to L/Cs on the rise, DCInsight
Vol. 9 No.2 April-June 2003.
[14] Case law on UNCITRAL texts (CLOUT) abstract no. 172.
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