DRAFTING LETTERS OF CREDIT: BASIC ISSUES UNDER ARTICLE 5 OF THE UNIFORM COMMERCIAL CODE, UCP 600, AND ISP98 JEFFREY S. WOOD This article compares the treatment of various letter of credit issues under Article 5 of the New York Uniform Commercial Code (“Article 5”), the Uniform Customs and Practice for Documentary Credits 2007 Revision, International Chamber of Commerce Publication No. 600 (“UCP 600”), and the International Standby Practices (“ISP98”) published by the Institute for International Banking Law and Practice, and outlines some considerations relevant to those drafting letters of credit, particularly standby letters of credit and related issuance or reimbursement agreements. The discussion is intended primarily for those who are not experienced letter of credit practitioners, and does not extend to the kinds of issues that may arise when a letter of credit involves multiple banks — for example, when one bank issues a letter of credit, a second bank confirms the credit (thus becoming independently liable to the beneficiary) and a third bank advises the credit to the beneficiary. L etters of credit normally fall into one of two broad types, known as “commercial” letters of credit and “standby” letters of credit.1 The distinction is based primarily on the business purpose served and not on the applicable legal principles or form. Commercial letters of credit, which Jeffrey S. Wood, of counsel to Debevoise & Plimpton LLP, can be reached at [email protected] The author expresses special thanks to Carlos Gouvea of Debevoise & Plimpton LLP for his assistance in the preparation of this article. 103 Published in the February 2008 issue of The Banking Law Journal. Copyright ALEXeSOLUTIONS, INC. BANKING LAW JOURNAL in concept date back hundreds of years, are used primarily to ensure payment of the purchase price for goods moving in international trade — a buyer arranges a letter of credit in favor of a seller, who can draw on the letter of credit by delivering evidence that the goods have been shipped (such as a carrier bill of lading, an independent inspection report covering the goods, and evidence of insurance of the shipment). By contrast, standby letters of credit, which have come into use in the last forty years or so, are used primarily to provide third-party credit support for specific financial obligations of persons (such as the obligation of a contractor to make liquidated damage payments if a completed project underperforms).2 The term “credit” is used in this article to refer generically to any type of letter of credit, while commercial letters of credit are referred to as “commercial credits” or “trade credits” and standby letters of credit are referred to as “standbys” or “standby credits.”3 By its terms, Article 5 of the Uniform Commercial Code is applicable to all types of letters of credit. In its present form, Article 5 dates from 1995, and has been adopted by all States and the District of Columbia. It became effective in New York on November 1, 2000.4 The revision notes to Article 5 indicate that the revision sought: (1) to emphasize the independence principle5 and to conform the Article to current domestic and international customs and practices, (2) to accommodate evolving technology, particularly the use of electronic media, (3) to maintain letters of credit as inexpensive and efficient instruments, and (4) to resolve conflicts among existing decisions. UCP 600 is a 2006 revision of the rules of practice for letters of credit prepared under the auspices of the International Chamber of Commerce (the “ICC”) that became effective on July 1, 2007. It replaced UCP 500, released in 1993.6 The creation and adoption of UCP 600 seems to have been triggered, in large part, by a high frequency of excessively technical rejections of documents7 presented under UCP 500 commercial credits. The ICC drafting committee responded to this by significantly reorganizing the text of the 104 Published in the February 2008 issue of The Banking Law Journal. Copyright ALEXeSOLUTIONS, INC. DRAFTING LETTERS OF CREDIT rules, adopting new, more comprehensive definitions and interpretations and changing the rules for examination of documents presented. Although UCP 600, like UCP 500, states that it is applicable to all forms of letter of credit, its focus is commercial credits, where payment is typically made against the presentation of documents that may include complex bills of lading, product inspection reports, insurance documents and other documents common in international trade.8 ISP98 is a product of the Institute of International Banking Law and Practice and became effective on January 1, 1999. As its full name indicates, ISP98 deals exclusively with standby credits. ISP98 is primarily the product of American bankers and lawyers operating through the U.S. Council on International Banking (the predecessor of the International Financial Services Association), and its style does seem to reflect the fact that more lawyers were involved in its drafting than in the drafting of UCP 600.9 However, because it is generally issuer-favorable, many non-US banks today prefer to issue standby credits pursuant to Article 5 (or another defined local law) and ISP98. THE “INDEPENDENCE PRINCIPLE” The most important component of modern letter of credit practice is the “independence principle” — the principle that payment under a credit will be made solely against receipt by the issuer10 of the documents called for in the credit, without regard to the relationships between and the relative rights and obligations to each other of (i) the beneficiary and the party who procured the issuance of the credit (normally known as the “applicant”), or (ii) the issuer and the applicant. The independence principle is embedded in all three sets of rules: UCC 5-103(d),11 UCP 600 Arts 4(a) and 5,12 and ISP98 Rule 1.06(c) and 1.07.13 In essence, the letter of credit issuer is saying “if you give me the following pieces of paper14 that say the following things then I will pay you the stated amount without regard to the terms of my agreements with the applicant or your agreements with the applicant.” The issuer is neither expected nor entitled to look behind the pieces of paper to determine whether the statements they contain are true, or to determine whether under its agreements with the applicant, the beneficiary has the right to make 105 Published in the February 2008 issue of The Banking Law Journal. Copyright ALEXeSOLUTIONS, INC. BANKING LAW JOURNAL demand under the letter of credit. From the viewpoint of the beneficiary, the “independence principle” makes a letter of credit superior to a normal surety bond or guarantee, in which the surety’s or guarantor’s liability (i) doesn’t arise until the liability of the person whose obligations are supported by the bond or guarantee has been proved or admitted, and (ii) may be subject to defenses based on actions or lack thereof on the part of such person or the beneficiary. The independence principle is not, however, absolute. Although it is the independence principle that makes letters of credit superior (from the viewpoint of the beneficiary) to ordinary guarantees or surety bonds, the reliance on documents inherent in letter of credit practice carries with it the clear risk of fraud or forgery. A serious discussion of the issues involved in balancing the independence principle against the risk of documentary fraud is beyond the scope of this article, but a basic outline appears below. APPLICABILITY OF ARTICLE 5, UCP 600, AND ISP98 One must begin by keeping in mind the difference between Article 5, on the one hand, and UCP 600 and ISP98, on the other. Article 5 is the law of each jurisdiction that has adopted the UCC, and thus will be applicable to any credit that is subject to the laws of such jurisdiction. UCP 600 and ISP98 are not law, but rather private compilations of generally agreed-upon rules, and by their terms are applicable only if the parties agree that they are applicable.15 However, an agreement by the parties to make UCP 600 or ISP98 applicable to a credit otherwise governed by Article 5 has results that can easily be overlooked by a beginner. This comes about through the operation of UCC 5-116(3)(c), which provides that if “the liability of an issuer” is governed by Article 5, if the credit incorporates rules of custom or practice (such as UCP 600 or ISP98), and if there is conflict between Article 5 and the incorporated rules of custom or practice, then the rules of custom or practice will prevail over Article 5, except as to certain non-variable provisions identified in UCC 5-103 and discussed below.16 The potential impact of this provision is significant. For example, UCC 5-108(a)17 requires that documents presented under the credit “strictly” com106 Published in the February 2008 issue of The Banking Law Journal. Copyright ALEXeSOLUTIONS, INC. DRAFTING LETTERS OF CREDIT ply with the terms of the credit. However, UCP 600 Art 14 does not use the term “strict” and contains a number of provisions designed to make it more difficult for issuers to dishonor a presentation containing insignificant inconsistencies or errors. Thus, if the credit simply says it is subject to Article 5 and UCP 600, the standard of UCP 600 Art 14 should trump the standard of UCC 5-108(a). If the drafter of a credit wants UCP 600 or ISP98 to supplement, rather than supplant the provisions of Article 5, care must be taken in the governing law clause. Consider the following governing law formulation, which the author has seen in several credits: “This standby letter of credit is subject to and governed by the laws of the State of New York and UCP 600 and in the event of any conflict the laws of the State of New York will control.” The trouble with this formulation is the precise language of UCC 5116(3), which effectively states that if the credit has adopted UCP 600, then in the event of any conflicts UCP 600 shall control. One can easily argue that because of the language of UCC 5-116(3), there cannot be a conflict between Article 5 and UCP 600 because as a matter of law Article 5 itself provides that all conflicts (other than those relating to the non-variable provisions of Article 5) must be resolved in favor of UCP 600. If the parties want the provisions of Article 5 to supersede all inconsistent provisions of UCP 600, it would be better to have the governing law clause remove any ambiguity as to the impact of UCC 5-116(3). This could be done, albeit somewhat verbosely, as follows: “This standby letter of credit is subject to and governed by the laws of the State of New York and UCP 600. For all purposes of this standby letter of credit, any provision of UCP 600 that, if applied, would conflict with Article 5 of the New York Uniform Commercial Code but for the application of Section 5-116(3) of such Article 5 shall be deemed excluded from UCP 600.”18 In addition, each of UCP 600 and ISP98 contains provisions that are purportedly binding on applicants if the credit is issued subject to UCP 600 or ISP98. ISP98 Rule 1.04 states this explicitly: “These Rules apply as terms and conditions incorporated into a standby, confirmation, advice, nomination, amendment, transfer, request for issuance, or other agreement of (i) the issuer, (ii) the beneficiary, to the extent it uses the standby…and (vi) the applicant who authorizes the standby or otherwise agrees to the application 107 Published in the February 2008 issue of The Banking Law Journal. Copyright ALEXeSOLUTIONS, INC. BANKING LAW JOURNAL of these Rules.”19 UCP 600 is not so explicit, stating that if a credit expressly indicates that it is subject to these rules, it is “binding on all parties thereto,” leaving open the question of the extent to which the applicant is a “party.” But the clear expectation of each of UCP 600 and ISP98 is that the applicant will be bound by its provisions, insofar as they purport to assign obligations or liabilities to the applicant. In each case one can wonder about the extent to which an applicant may be bound by the relevant set of rules if its agreement with the issuer did not specify any governing rules beyond New York law and the issuer unilaterally issues the credits subject to ISP98 or UCP 600.20 Rather than worry about the outcome of litigation, however, it makes more sense for an applicant to agree with the issuer on the use or non-use of one of these supplementary sets of rules, and then decide whether selective exceptions to the applicability of the selected rules must be negotiated. Below, this article discusses this issue as it relates to indemnification obligations purportedly imposed on applicants by UCP 600 and ISP98.21 THE PROTECTED PROVISIONS OF ARTICLE 5 Under UCC 5-103(c), the parties to an Article 5 credit may vary the provisions of Article 5 by agreement (and as noted above will be deemed to have agreed to vary them to the extent necessary to give effect to UCP 600 or ISP98 if those rules are made applicable to the credit), except that they may not vary: • 5-103(c) itself; • 5-102(a)(9) (definition of “issuer”);22 • 5-102(a)(10) (definition of “letter of credit”);23 • 5-103(a) (statement that Article 5 applies to letters of credit and certain rights and obligations arising out of transactions involving letters of credit); • 5-103(d) (statement of the “independence” principle); • 5-106(d) (when a letter of credit stated to be perpetual expires as a mat- 108 Published in the February 2008 issue of The Banking Law Journal. Copyright ALEXeSOLUTIONS, INC. DRAFTING LETTERS OF CREDIT ter of law); and • 5-114(d) (no obligation to consent to assignment of proceeds, but prohibition of unreasonable refusal in certain cases). UCC 5-103(c) also provides that the parties cannot modify by agreement the prohibition in UCC 1-102(3) of any disclaimer of the obligations of good faith, reasonableness, diligence, and care prescribed in the UCC24 or the limitation on rights of subrogation under UCC 5-117(d). GOVERNING LAW The choice of law applicable to a credit may be of critical importance to both applicants and beneficiaries, particularly when questions of fraud or forgery arise. Some jurisdictions — generally not significant commercial law jurisdictions — have perhaps been overly free in responding favorably to applicant claims that a purported draw is fraudulent. England, on the other hand, has for the most part been reluctant to allow fraud or forgery claims to interfere with the independence principle.25 UCC 5-116(a) contains a very flexible choice of law provision: the parties are free to choose any law at all as the governing law of the credit by identifying the governing law in the credit instrument or in a suitably authenticated or signed agreement among the affected parties.26 It also expressly provides that the chosen jurisdiction “need not bear any relation to the transaction.” This rule deserves careful thought in the context of an international transaction if a possible party to any litigation concerning the credit may reside (and may try to bring suit) in a jurisdiction in which the UCC 5-116 choice of law provision could be viewed as being against local public policy. Thought is also required if a party to the transaction wants to choose the laws of a non-UCC jurisdiction, because most jurisdictions do not have a separate body of letter of credit law with either the breadth or depth of Article 5. First, the results of litigation under the laws of such a jurisdiction will probably be less predictable. Second, because Article 5 contains provisions relating to the rights of applicants vis-à-vis the issuer as well as the 109 Published in the February 2008 issue of The Banking Law Journal. Copyright ALEXeSOLUTIONS, INC. BANKING LAW JOURNAL rights of beneficiaries vis-à-vis the issuer, the applicant and the issuer will each want to think carefully about the potential consequences of using any law other than New York law in any separate reimbursement agreement if the credit itself will be governed by New York law.27 Third, if the governing law is not Article 5, inconsistencies between the terms of UCP 600 or ISP98 on the one hand, and the requirements of governing law, on the other hand, may be resolved across the board in favor of the governing law, in complete contrast to the subordinate status of Article 5 under UCC 5-116(c)(3). For example, ISP98 Rule 3.10 excuses an issuer from any duty to notify the applicant of a draw under a credit, but German law may require such a notification.28 If the parties fail to specify a choice of law, UCC 5-116(b) provides that the liability of an issuer, a nominated person (e.g., a confirming bank) or an advising bank “is governed by the law of the jurisdiction in which [such] person is located,” and that for the purposes of determining jurisdiction and choice of law, each branch of a bank is to be viewed as a separate juridical entity.29 Under this rule, it seems that a New York court would have to apply Dutch law to a credit issued by and to be presented at the home office of a Dutch bank if no choice of law was stated in the credit, even if the credit was negotiated with personnel from the bank’s New York branch and the credit was delivered to the beneficiary through the New York branch. Further, if the credit was later confirmed by a branch of the issuer located in Hong Kong, again without any stated choice of law, the liabilities of the issuer would be determined under Dutch law, but the liabilities of the confirmer would be determined under Hong Kong law. UCP 600 and ISP98 do not have default choice of law rules, which is appropriate, as each of them represents a commercial agreement on terms and conditions of a contractual relationship rather than a body of law. Each of them, however, attempts to shield an issuer from economic harm if the credit is structured to be subject to, or is determined by a court to be subject to, the laws of a jurisdiction other than the jurisdiction in which the issuer is located. UCP 600 Art 37(d) requires the applicant to indemnify the issuer “against all obligations and responsibilities imposed by foreign laws and usages.” ISP98 Rule 1.08(d) provides that “[a]n issuer is not responsible for…observance of law or practice other than that chosen in the standby or 110 Published in the February 2008 issue of The Banking Law Journal. Copyright ALEXeSOLUTIONS, INC. DRAFTING LETTERS OF CREDIT applicable at the place of issuance,” and ISP98 Rule 8.01(b)(i) requires the applicant to indemnify the issuer against all claims arising out of “the imposition of law or practice other than that chosen in the standby or applicable at the place of issuance.”30 In considering the choice of law implications for the prospective liability (and in determining the actual liability) of parties to a credit, it is also necessary to keep in mind UCP 600 Art 3, which states that branches of a bank in different jurisdictions are considered to be separate entities, and ISP98 Rule 2.02, which states that if a branch, agency or other office of a bank is acting under a credit in a capacity other than issuer, then it is deemed a different person from the issuer, without regard to the jurisdiction in which it is located. While these are not in themselves choice of law clauses, they will undoubtedly be used to complicate any choice of law questions that may arise in litigation concerning a credit involving multiple parties. Finally, drafters may occasionally be told by letter of credit technicians who are not lawyers that a letter of credit does not require a governing law clause if it incorporates UCP 600 or ISP98. This is a bad idea, because UCP 600 and ISP98 are not complete. If the letter of credit is subject only to UCP 600 or ISP98, without a governing law clause, and litigation arises relating to matters not spelled out in the applicable set of rules (such as the rights of an applicant and an issuer when a presentation appears to be tainted by fraud or forgery, the applicable statute of limitations, the scope of remedies, or, in the case of UCP 600, transfers of credits by operation of law or assignments of proceeds), a court will need to determine and apply an appropriate body of law. In summary, the drafter of a credit representing the applicant or the beneficiary should ensure that a sensible choice of law is made, reflect that choice in the documentation of the credit, and make sure that the courts of the jurisdiction in which each potentially adverse party is located (as that may be determined under the law chosen) will give effect to that choice of law. 111 Published in the February 2008 issue of The Banking Law Journal. Copyright ALEXeSOLUTIONS, INC. BANKING LAW JOURNAL MODIFICATION OF UCP 600 AND ISP98 UCP 600 Art 1 provides that if a credit is subject to UCP 600, its rules “are binding on all parties thereto unless expressly modified or excluded by the credit.” ISP98 Rule 1.01(c) provides that “[a]n undertaking subject to these Rules may expressly modify or exclude their application.” How “express” must a modification or exclusion be? UCP 600 does not purport to answer that question, and the question probably is not relevant when the drafter of a credit seeks to eliminate a single specific provision of the relevant set of rules, as it will be difficult to do so without being “express.” The question could become significant if a more general (or less obvious) form of modification is used. An applicant will normally consider that its agreement with the issuer providing for issuance of the credit is the document that sets forth the relative rights and obligations of the applicant and the issuer. But UCP 600 contains provisions defining the rights and obligations of the issuer and the applicant. Will issuance agreement provisions inconsistent with UCP 600 override UCP 600 (i) if the issuance agreement accepts that the credit will be issued subject to UCP 600 but does not specifically provide that UCP 600 is subordinate to the issuance agreement insofar as it purports to govern the relative rights and obligations of the issuer and the applicant, or (ii) if the issuance agreement is silent as to the role of UCP 600, but the issuer elects to issue the credit subject to UCP 600? ISP98 has even more “underbrush” to complicate the modification/exclusion issue. Note that Rule 1.11(d), which distinguishes between the phrases “unless a standby otherwise states” and “unless a standby otherwise expressly states.” According to Rule 1.11(d), the latter phrase means that the rules of ISP98 “should be excluded or modified only by wording in the standby that is specific and unambiguous.” Moreover, Rule 1.11(d) also distinguishes between the phrases “stated in the standby” and “provided in the standby”: as used in ISP98, the latter is to be interpreted to incorporate both the text of the standby and the Rules (except to the extent excluded by the express terms of the standby), while the former refers only to the express text of the standby. Finally, the ISP Commentary notes that an attempt to vary a specific Rule of ISP98 should be treated as an attempt to modify the terms of the Rule rather than a total exclusion of the Rule unless 112 Published in the February 2008 issue of The Banking Law Journal. Copyright ALEXeSOLUTIONS, INC. DRAFTING LETTERS OF CREDIT the text clearly indicates an attempt to exclude the entire Rule.31 These provisions will undoubtedly benefit issuers intimately familiar with ISP98 at the expense of less familiar applicants and beneficiaries. The most sensible drafting approach is to specify in the issuance agreement what rules (if any) the issuer will incorporate in the credit, and to make all intended exclusions from those rules “express and unambiguous.” INCORPORATION OF UCP 600 OR ISP98 PRACTICES WHEN NOT EXPRESSLY APPLICABLE TO THE CREDIT If you are litigating rather than drafting a letter of credit and related documentation and Article 5 is the governing law, it is worth remembering that UCC 5-108(e) provides an opening for reading into Article 5 elements of UCP 600 or ISP98 without specifying either in the documentation. The section states that an issuer shall observe “standard practice of financial institutions that regularly issue letters of credit.”32 This language makes it possible to argue that basic operating rules of UCP 600 (for example, implementation of transfers of credits, reimbursement of confirming banks, advising of amendments and document examination procedures), or their parallels in ISP98 if a standby credit is involved, are imported by this language into Article 5 at least to the extent those operating rules can be shown to represent “standard practice.”33 WHO MAY ISSUE A LETTER OF CREDIT The three sets of rules are not consistent in identifying who may issue a credit. Article 5 clearly contemplates that almost anyone may issue a letter of credit, with two exceptions. First, UCC 5-102(9) excludes from the category of “issuer” an individual who makes an engagement for “personal, family or household purposes.” UCC 5-102(9) is one of the non-variable provisions, so a proposed issuance of a credit by an individual should be handled with great caution because of the difficulty in establishing whether a credit is for “personal” purposes. Second, UCC 5-102(10) excludes from the defined term “letter of credit” a credit issued for its own account by an entity that is 113 Published in the February 2008 issue of The Banking Law Journal. Copyright ALEXeSOLUTIONS, INC. BANKING LAW JOURNAL not a “financial institution.” UCP 600 on its face appears to be applicable only to bank issuers, as it expressly refers to the issuers of credits as “issuing banks”34 and uses the more generic term “issuer” throughout to refer more generally to any entity that issues a document required for presentation under a credit. But UCP 600 Art 1 states that the parties are free to modify UCP 600, which presumably means that if they expressly so provide, they could make UCP 600 applicable to a non-bank issuer notwithstanding the definition of “issuing bank.” ISP98, on the other hand, does not even define “issuer,” and although the drafters seem to have assumed that an “issuer” would be a bank, there is nothing within ISP98 that is inconsistent with the notion that a non-bank may issue a standby credit subject to ISP98. It is very important to remember, though, that a non-bank issuer is not likely (unless it is someone like General Electric Capital Corporation) to have in-house staff familiar with the rules for issuance and administration of credits, particularly the rules covering examination, honor and dishonor of presentations under the credit. If the issuer lacks such experience, there is a real potential for costly mistakes when the time comes for the issuer to honor or dishonor a presentation under the credit. WHEN A LETTER OF CREDIT IS ISSUED Under UCC 5-106(a), a credit is enforceable when “transmitted” by the issuer to the beneficiary or a person requested to advise it to the beneficiary. Under UCP 600 Art 7(b), the credit is enforceable against the issuer “as of the time it issues the credit.” Under ISP98 Rule 2.03, the credit is binding on the issuer when it “leaves the issuer’s control unless it clearly specifies that it is not then ‘issued’ or ‘enforceable.’”35 Under each of these formulations, a SWIFT-transmitted credit is issued when the issuer punches the computer button to send it to an advising bank with instructions to advise it to the beneficiary, even if the beneficiary may not become aware of the issuance for several days, or even longer. Each of these formulations may require a little thought in a complicated multi-location closing, or in the negotiation of a complex standby credit, particularly when drafts may be passing back and forth through SWIFT. 114 Published in the February 2008 issue of The Banking Law Journal. Copyright ALEXeSOLUTIONS, INC. DRAFTING LETTERS OF CREDIT ISSUER DISCRETION IN SETTING THE TERMS OF THE CREDIT UCP 600’s related document, ISBP No. 681, contains the following provision in ¶2: “The applicant bears the risk of any ambiguity in its instructions to issue or amend a credit. Unless expressly stated otherwise, a request to issue or amend a credit authorizes an issuing bank to supplement or develop the terms in a manner necessary or desirable to permit the use of the credit.” This clause, while commercially logical (most applicants don’t know as much about the technical details of credits as most issuers), could yield unanticipated results in a case in which an applicant wishes a credit to serve an unusual purpose but does not discuss fully with the issuing bank how the credit is to be drafted to reflect that particular purpose.36 Counsel for such an applicant must make sure that the details of a credit in non-customary form or for a non-customary purpose are reflected in the context of the issuer’s agreement to issue the credit (or that the applicant and its counsel will have the opportunity to review the actual terms of the credit prior to its issue).37 CONSENT OF BENEFICIARY TO AMENDMENT OF A CREDIT UCP 600, ISP98, and Article 5 each deal differently with amendments to a credit. Under UCP 600 Art 10, an amendment is binding on the issuer “as of the time it issues the amendment” but the beneficiary continues to be entitled to the benefit of the original letter until it has accepted the amendment. ISP98 Rule 2.06 is similar: the amendment is binding on the issuer when it “leaves the issuer’s control,” and the beneficiary is not bound by the amendment until it consents to it. UCC 5-106(b) simply states that the rights of the beneficiary are not affected by an amendment to which it has not consented, and does not provide for any form of deemed consent. There is a built-in beneficiary “trap” in UCP 600 Art 10(c). That article deems the beneficiary to have consented to an amendment if the beneficiary makes a presentation that complies with the original credit and with any not yet accepted amendment. While it may be true that most amend115 Published in the February 2008 issue of The Banking Law Journal. Copyright ALEXeSOLUTIONS, INC. BANKING LAW JOURNAL ments to a commercial credit will end up affecting the terms of any presentation by the beneficiary, it is unfortunately easy to think of an amendment to a standby credit that (i) is unfavorable to the beneficiary and (ii) would not change the presentation requirements.38 Note that because UCC 5-106 is not one of the non-variable provisions of Article 5 specified in UCC 5-103, the incorporation of UCP 600 into an Article 5 credit will result in the UCP Art 10 “deemed consent” provision superseding the amendment provisions of UCC 5-106. ISP98 avoids (or at least minimizes) the whole problem by providing in Rule 2.06(c) that the beneficiary is deemed to have accepted an amendment by making a presentation complying with the amendment only if the presentation, as made, would not have complied with the original standby. Both ISP98 Rule 2.06(a) (in many words) and UCC 5-106(b) (in few words) clearly permit so-called “automatic amendments” (i.e., provisions frequently found in standbys increasing or decreasing amounts available with the passage of time or upon the occurrence of stated events, or extending expiration dates) without the consent of the beneficiary if the credit expressly permits such amendments. UCP 600 contains no such provision, and if an applicant wants an automatic amendment provision in a UCP 600 credit that is not also subject to Article 5, one must consider whether applicable local law is receptive or hostile to automatic amendments. Both ISP98 and UCP 600 provide that partial consent to an amendment is not permitted. Because the amendment as a whole is binding on the issuer from the time it is issued or leaves the issuer’s control, it is inappropriate to permit the beneficiary to pick and choose among the desirable and undesirable portions of the amendment.39 Although Article 5 is silent on this point, a New York court ought to find this rule (which also appeared in UCP 500) to be standard letter of credit practice and apply the rule under UCC 5108(e)40 even if the credit did not incorporate any of those rules of practice.41 CONSENT OF APPLICANT TO AMENDMENT OF A CREDIT UCC 5-106(b) provides that the rights and obligations of an applicant are not affected by an amendment to which the applicant has not consented. Although both UCP 600 Art 10(a) and ISP98 Rule 2.06(c)(iii) are silent as 116 Published in the February 2008 issue of The Banking Law Journal. Copyright ALEXeSOLUTIONS, INC. DRAFTING LETTERS OF CREDIT to the impact of an amendment on the applicant, the ISP Commentary clearly states that the rights and obligations of the applicant vis-à-vis the issuer are not affected by an amendment to which the applicant has not consented,42 and consideration of the implications of the independence principle indicates that this should be the result for a UCP 600 credit as well. NON-DOCUMENTARY CONDITIONS IN A CREDIT A “non-documentary condition” exists when a credit sets forth a condition to be satisfied before the beneficiary may draw upon the credit but does not set forth a document to be delivered to the issuer to establish the satisfaction of the condition. UCC 5-108(g) and UCP 600 Art 14(h) both state flatly that if a credit contains a condition without identifying the document to be delivered to establish compliance with the condition, the condition will be disregarded. ISP98 Rule 4.11 similarly provides that non-documentary conditions must be ignored, but goes on to qualify this by excluding from the category of “non-documentary conditions those conditions the existence of which can be determined by the issuer from the issuer’s own records or within the issuer’s normal operations” and goes on to make it clear that this exclusion includes conditions the existence of which can be determined through the consultation of “published indexes.”43 Application of the rule that non-documentary conditions must be ignored could be devastating to an applicant that had assumed a material non-documentary condition would be satisfied prior to the credit being drawn. The correct approach is to avoid non-documentary conditions entirely (except, in an ISP98 credit, those falling within the Rule 4.11 exclusion and carefully discussed with the issuer). But if the applicant (or the issuer) has been careless and a significant non-documentary condition has slipped through, there is some US case law44 to the effect that if an instrument purports to be a “letter of credit” but contains non-documentary conditions that are fundamental to the business intent of the parties, a court will not allow the issuer to treat the instrument as an Article 5 letter of credit and ignore the existence of that condition, but will instead treat it as an ordinary contract of suretyship or a contract of guar117 Published in the February 2008 issue of The Banking Law Journal. Copyright ALEXeSOLUTIONS, INC. BANKING LAW JOURNAL antee rather than a letter of credit.45 In that case, the obligation of the issuer remains alive and the beneficiary is free to demonstrate satisfaction of the relevant condition as a matter of ordinary contract law. This result protects the expectations of the applicant, but may, of course, frustrate the beneficiary who now must prove the satisfaction of the condition to be able to claim under the instrument, and whose right to claim is subject to all of the collateral challenges to which an ordinary guarantee may be subject. TIME FOR EXAMINATION/NOTICE OF DISHONOR/NOTICE OF EXPIRY Under UCP 600 Art 16, notice of discrepancies must be given no later than the close of the fifth banking day following the day of presentation, and must be given by telecommunication or, if that is not possible, by other “expeditious” means. Under Art 16(c), the issuer must give notice of discrepancies “when” it decides not to “honor,” and under Art 15(a) the issuer must honor “when” it determines that there are no discrepancies. This language is intended to prevent the issuer from deciding to honor or dishonor and then waiting until the end of the five-business day period to honor or give notice of dishonor. Under ISP98 Rule 5.01(a), notice of dishonor must be given within a time after presentation of documents “which is not unreasonable,” with notice given within three business days following the date of presentation being deemed not unreasonable and notice given beyond seven business days being deemed unreasonable. Like UCP 600 Art 16(d), ISP98 Rule 5.01(b)(i) requires that notice of dishonor be given by telecommunication, or if not possible, by other “prompt” means. However, ISP98 contains no provisions similar to UCP 600 Art 15(a) and 16(c), and indeed seems to limit the scope of the “reasonableness” requirement by stating, in Rule 5.01(a)(iv), that the issuer has no obligation to accelerate its examination of documents within the seven day period unless the credit specifies a shortened time for the giving of notice of dishonor.46 Under UCC 5-108(b), the issuer has a reasonable time after presentation, but not beyond seven business days after the day upon which it receives the documents, to give notice of discrepancies in the presentation. While 118 Published in the February 2008 issue of The Banking Law Journal. Copyright ALEXeSOLUTIONS, INC. DRAFTING LETTERS OF CREDIT there are no provisions in Article 5 comparable to UCP 600 Art 15(a) or 16(c), but because Article 5 has no parallel to ISP98 Rule 5.01(a)(iv), waiting until the sixth business day to complete document examination could well be deemed unreasonable under all the facts and circumstances.47 None of Article 5, UCP 600, or ISP98 requires that notice of dishonor be given to any person other than the “presenter” unless otherwise requested by the presenter.48 If the presenter will be a third party acting on behalf of the beneficiary (as could happen in a multi-jurisdictional transaction) the beneficiary may wish to provide in the credit that any notice to a presenter must be given concurrently to the beneficiary (and to take such steps as it can to make sure that the presenter refers to this requirement in any presentation). Each of Article 5, UCP 600, and ISP98 requires the issuer to include all discrepancies in its notice of discrepancy. Issuers must understand that once the notice is given, new discrepancies cannot be raised on the same documents.49 Thus if an issuer, when presented with both an obviously incomplete presentation and one or more presented documents that themselves contain discrepancies, rejects the presentation solely on the grounds that it is incomplete, the issuer will thereafter be barred from raising the documentary discrepancies when the beneficiary makes a future complete presentation. There are certain exceptions to the rules outlined above. UCC 5-108(d) and ISP98 Rule 5.04 permit an issuer to give at any time notice that a presentation was discrepant because it was made after the expiration of the last date for presentation (or after the expiry of the credit). UCC-5-108(d) also gives the issuer a similar right if honor is excused by fraud or forgery. LAST DATE FOR PRESENTATION FALLING ON A NONBUSINESS DAY Article 5 is silent as to what happens if the last day for presentation falls on a non-business day. ISP98 Rule 3.13 provides that if the expiration date or the last day for presentation stated in a standby is not a business day50 of the issuer, the presentation is deemed timely if made on the first following business day. UCP 600 Art 29(a) is similar, providing that if on the expiration date or last day for presentation the issuer is closed for reasons other than 119 Published in the February 2008 issue of The Banking Law Journal. Copyright ALEXeSOLUTIONS, INC. BANKING LAW JOURNAL force majeure (as described in UCP 60 Art 36) the presentation is deemed timely if made on the first following banking day.51 Counsel representing a beneficiary in a credit not subject to ISP98 should consider incorporating the substance of Rule 3.13 in a credit subject only to Article 5, or eliminating the force majeure exception in Art 29(a) in a UCP 600 credit. ISSUER CLOSED ON ACCOUNT OF FORCE MAJEURE Article 5, ISP98 and UCP 600 deal with force majeure in very different ways. Article 5 is silent as to the impact of a force majeure event that causes an issuer’s offices to be closed on the last day for presentment of documents. Presumably, applicable local law will govern if specific provision is not made in the credit. ISP98 Rule 3.14(a) is highly favorable to beneficiaries: “If on the last business day for presentation the place for presentation stated in a standby is for any reason closed and presentation is not timely made because of the closure, then the last day for presentation is automatically extended to the day occurring thirty calendar days after the place for presentation reopens for business, unless the standby otherwise provides.”52 By contrast, UCP 600 Art 36 absolves the issuer from any responsibility for a force majeure event that prevents presentation from occurring, and goes on to provide that upon the reopening of the issuer’s business, the issuer will not accept a presentation made under a credit that expired during the period of interruption. Counsel representing a beneficiary under a standby credit not subject to ISP98 will normally seek to exclude Art 36 (if it is a UCP 600 credit) and to include something along the lines of the more favorable language of ISP98 Rule 3.14(a).53 STANDARD OF DOCUMENT EXAMINATION There are significant differences in the document review standards applicable under the three systems. UCC 5-108 arguably sets the strictest 120 Published in the February 2008 issue of The Banking Law Journal. Copyright ALEXeSOLUTIONS, INC. DRAFTING LETTERS OF CREDIT review standard. It provides that “an issuer shall honor a presentation that, as determined by the standard practice [of financial institutions that regularly issue letters of credit]…, appears on its face strictly to comply with the terms and conditions of the letter of credit,” subject to the provisions relating to fraud and forgery under UCC 5-109. [Emphasis added.] Under UCP 600 Art 14(a), “the issuing bank must examine a presentation to determine, on the basis of the documents alone, whether or not the documents appear on their face to constitute a complying presentation.” The comparable provision of UCP 500 (Art 13.A) included the words “with reasonable care” after “examine a presentation,” and an applicant with bargaining power may want to consider seeking reinsertion of those words in a UCP 600 credit. But the bigger change in UCP 600 was the elimination of the requirement in UCP 500 Art 13.A that “[d]ocuments which appear on their face to be inconsistent with one another will be considered as not appearing on their face to be in compliance with the terms and conditions of the Credit” — a requirement believed by the drafters of UCP 600 to have resulted in an excessive number of presentations being dishonored for essentially trivial inconsistencies. The offending language was replaced by four new provisions designed to limit the role played by immaterial inconsistencies or errors in a presentation:54 • Data in a document, when read in context with the credit, the document itself and international standard banking practice, need not be identical to, but must not conflict with, data in that document, any other stipulated document or the credit. (Art 14(d))55 • In documents other than the commercial invoice, the description of the goods, services or performance, if stated, may be in general terms not conflicting with their description in the credit. (Art 14(e)) • If a credit requires presentation of a document other than a transport document, insurance document or commercial invoice, without stipulating by whom the document is to be issued or its data content, banks will accept the document as presented if its content appears to fulfill the function of the required document and otherwise complies with subarticle 14(d). (Art 14(f )) 121 Published in the February 2008 issue of The Banking Law Journal. Copyright ALEXeSOLUTIONS, INC. BANKING LAW JOURNAL • When the addresses of the beneficiary and the applicant appear in any stipulated document, they need not be the same as those stated in the credit or in any other stipulated document, but must be within the same country as the respective addresses mentioned in the credit. Contact details (telefax, telephone, email and the like) stated as part of the beneficiary’s and the applicant’s address will be disregarded. However, when the address and contact details of the applicant appear as part of the consignee or notify party details on a transport document subject to articles 19, 20, 21, 22, 23, 24 or 25, they must be as stated in the credit. (Art 14(j)) By contrast, under ISP98 Rule 4.01(b) the issuer must “examin[e] the presentation on its face against the terms and conditions stated in the standby as interpreted and supplemented by these Rules which are to be read in the context of standard standby practice.” This standard leaves both beneficiaries and applicants a little up in the air. Applicants may fear that the issuer will overlook material inconsistencies. Beneficiaries may fear the application of a “strict compliance” rule.56 In addition, ISP98 Rule 4.03 expressly disavows any requirement to examine documents for inconsistency except to the extent required by the terms of the standby.57 It is reasonable to expect that banks will resist any requirement in a credit relating to documentary consistency, but the omission of a consistency review should not be of major concern to applicants for standby credits when the documentation to be presented to draw under the credit is spelled out in detail in the credit.58 Remember that under UCC 5-116(c)(3), if the credit is subject to UCP 600 or ISP98, the UCP 600 or ISP98 document review standard will replace the UCC 5-108 standard unless the appropriate exceptions to UCP 600 or ISP98 are built into the credit.59 NON-OBVIOUS OPERATIONAL RULES Both UCP 600 and ISP98 contain general rules relating to the nature and form of documents presented. Applicants and beneficiaries alike should make sure at the time the credit is first issued that these rules are not counter to their expectations for the form or content of a particular document the 122 Published in the February 2008 issue of The Banking Law Journal. Copyright ALEXeSOLUTIONS, INC. DRAFTING LETTERS OF CREDIT presentation of which is required for a draw under the credit. Further, any beneficiary making demand under a credit (other than under a simple standby credit with fully defined presentation documents) would be well advised to review the applicable rules prior to making a presentation.60 Under UCP 600: • A document may be signed by handwriting, facsimile signature, perforated signature, stamp, symbol, or any other mechanical or electronic method of authentication. (Art 3) • A requirement for a document to be legalized, visaed, certified, or similar will be satisfied by any signature, mark, stamp, or label on the document which appears to satisfy that requirement. (Art 3) • If a credit requires a document (other than a transport or insurance document or commercial invoice), and does not specify issuer or content, banks will accept the document if its content appears to fulfill its function and it otherwise complies with Art 14(d). (Art 14(f )) • Terms such as “first class,” “well known,” “qualified,” “independent,” “official,” “competent,” or “local” used to describe the issuer of a document allow any person except the beneficiary to issue that document. (Art 3) • Unless required to be used in a document, words such as “prompt,” “immediately,” or “as soon as possible” will be disregarded. (Art 3) • The expression “on or about” or similar will be interpreted as a stipulation that an event is to occur during a period of five calendar days before until five calendar days after the specified date, both start and end dates included. (Art 3) • The words “to,” “until,” “till,” “from,” and “between” when used to determine a period of shipment include the date or dates mentioned, and the words “before” and “after” exclude the date mentioned. (Art 3) • The words “from” and “after” when used to determine a maturity date exclude the date mentioned. (Art 3) • At least one original of each document stipulated in the credit must be presented. (Art 17(a))61 123 Published in the February 2008 issue of The Banking Law Journal. Copyright ALEXeSOLUTIONS, INC. BANKING LAW JOURNAL • A bank shall treat as an original any document bearing an apparently original signature, mark, stamp, or label of the issuer of the document, unless the document itself indicates that it is not an original. (Art 17(b)) • Unless a document indicates otherwise, a bank will also accept a document as original if it: (i) appears to be written, typed, perforated or stamped by the document issuer’s hand; (ii) appears to be on the document issuer’s original stationery; or (iii) states that it is original, unless the statement appears not to apply to the document presented. (Art 17(c)) • If a credit requires presentation of multiple documents by using terms such as “in duplicate,” “in two fold,” or “in two copies,” this will be satisfied by the presentation of at least one original and the remaining number in copies, except when the document62 itself indicates otherwise. (Art 17(e)) ISP98 has a number of similar specific documentary presentation rules. For example: • A presentation that fails to identify the standby under which the presentation is made is not deemed presented until the date on which the issuer is able to match the presentation to the correct standby. (Rule 3.03(c)63 • Any government-issued document forming a part of a presentation must be originally certified or authenticated by an official of the issuing agency. (Rule 4.19) • All presented documents must be “originals” unless the standby specifies that a copy is permissible. (Rule 4.15)64 • The language of each document issued by the beneficiary must be in the language of the standby. No such requirement is applicable to third party documents, but examiners of presentations under standbys have no obligation to translate documents not in the language of the standby. (Rule 4.04, and Comments 2 and 4 to Rule 4.04 in the ISP Commentary)65 • A presentation must include a documentary demand for payment even if the standby is silent on the subject. (Rule 4.08) 124 Published in the February 2008 issue of The Banking Law Journal. Copyright ALEXeSOLUTIONS, INC. DRAFTING LETTERS OF CREDIT • If the standby requires a certificate of default and does not specify content, the certificate must contain a representation that payment is due because a drawing event described in the standby has occurred.66 (Rule 4.17) • Wrongful dishonor of a complying presentation does not constitute dishonor of any other presentation. (Rule 3.07(b))67 • If the discrepancy is apparent on the face of the documents, an applicant must timely object (using “prompt” means) to an issuer’s honor of a noncomplying presentation, or forfeit the opportunity of objecting. (Rule 5.09)68 • A required document need not be signed unless the credit or standard standby practice so requires. (Rule 4.07) • If the credit requires computations under a formula, the issuer has no obligation to verify the beneficiary’s calculations unless the standby so requires. (Rule 4.11(d)) • Each required document must be issued by the beneficiary unless the standby otherwise states or standard standby practice requires that it be issued by a third party. (Rule 4.05) In actual practice, if the forms of documents to be presented to the issuer under a standby credit are carefully described and set forth in exhibits to the credit, there are unlikely to be serious questions arising under the above provisions (unless the drafters erred in preparing the forms). And even in the context of a commercial credit facility, under which multiple credits, for differing commercial and/or standby purposes, may be issued over an extended period of time, it would not be difficult (if the issuer is somewhat flexible) to build specific documentary requirements into the credit when the default rules of UCP 600 or ISP98 are inconsistent with the applicant’s reasonable expectations. WAIVERS OF DISCREPANCIES IN PRESENTATIONS UCP 600 and ISP98 have decidedly different approaches to waiver by the applicant of discrepancies in a presentation, and Article 5 does not deal 125 Published in the February 2008 issue of The Banking Law Journal. Copyright ALEXeSOLUTIONS, INC. BANKING LAW JOURNAL with waivers at all. Under UCP 600 Art 16, an issuer receiving a non-complying presentation may, but is not required to, seek a waiver from the applicant. The article also appears to give the issuer full discretion as to whether it will accept the waiver and honor the presentation, or reject the waiver and dishonor the presentation.69 ISP98 deals in considerably more detail with waivers, but is based on the same principle: the issuer is not obligated to seek a waiver, even if requested by the presenter, and is not obligated to waive non-compliance even if the applicant grants the waiver.70 Beneficiaries under an ISP98 credit also need to remember that if the issuer dishonors a presentation and the beneficiary then requests the issuer to seek from the applicant a waiver of the non-complying document, the beneficiary is deemed under Rule 5.06(c)(i) to have waived any right it might otherwise have had to claim that the dishonor was improper under the terms of the credit. ISP98 is further complicated by Rule 3.11, which identifies certain ISP98 Rules that may be waived by the issuer without the consent of the applicant. Certain of these Rules, such as Rule 4.04, requiring that documents submitted in a presentation be in the language of the standby, Rule 4.05, barring post-dated documents and Rule 3.05(b), providing that a presentation after the close of business be deemed received on the next business day, could be of concern to an applicant;71 If an applicant wished to protect itself against a waiver of Rule 3.05(b) (which could in effect give the beneficiary the benefit of an extra business day to draw under the credit), it would have to obtain the agreement of the issuer not to exercise that right or require a provision in the credit stating that any presentation must be received by a time certain on the credit expiration date that is prior to the close of business of the issuer.72 Finally, ISP98 Rule 3.12 also permits the issuer to waive any requirement that the original be presented as a condition to honoring the standby. This is of potential significance to an applicant as presentation of the original letter of credit is one level of protection against the occurrence of a draw under a credit instrument based on forgery.73 126 Published in the February 2008 issue of The Banking Law Journal. Copyright ALEXeSOLUTIONS, INC. DRAFTING LETTERS OF CREDIT DISHONOR BASED ON FRAUD OR FORGERY More often than not, letter of credit litigation seems to involve allegations of fraud or forgery, and often delves deeply into the relationship between public policy notions that fraud should not be tolerated and the desire to protect the independence principle that underlies the commercial utility of letters of credit.74 UCC 5-109(a) sets out express, narrowly limited rules as to the circumstances under which an issuer may dishonor on the grounds of fraud or forgery. The section first identifies instances in which the issuer must honor in spite of fraud or forgery (basically, cases in which a prior actor, such as a confirmer acting in good faith or a holder in due course of a draft issued under a credit, has given value in connection with the credit), and then provides that in other cases, the issuer, acting in good faith, may honor or dishonor a presentation tainted by forgery or material fraud. UCC 5-109(b) further recognizes the right of an applicant or an issuer to seek, under narrowly limited circumstances,75 injunctive relief against a beneficiary to block a payment tainted by forgery or facilitated by a material fraud by the beneficiary. ISP98 Rule 1.05(c) affirmatively states that ISP98 does not provide for defenses to honor based on fraud, abuse, or similar matters, and that these matters are left to local law.76 By contrast, UCP 600 does not (and UCP 500 did not) contain any mention of fraud or forgery or any reference to local law. According to Professor Dolan, some lawyers used the silence of UCP 500 to argue that a credit governed by Article 5 and subject to UCP 500 eliminated the ability of an issuer to take advantage of fraud or forgery as a basis for dishonor, on the theory that UCC 5-109 is not one of the non-variable provisions of Article 5 identified in Article 5-103(c), and that the silence of UCP 500 on the fraud/forgery issue should be construed under UCC 5116(c)(3) as an intent to override the provisions of UCC 5-109. He concludes, however, that the better reading is simply that UCP 500 (which is not “law”) is silent as to the fraud or forgery question, and that applicable local law continues to govern.77 Although ISP98 clearly seeks to preserve whatever rights the issuer and applicant may have under local law in case of fraud or forgery in a presentation, it also seeks to limit any duty of the issuer to consider whether a draw127 Published in the February 2008 issue of The Banking Law Journal. Copyright ALEXeSOLUTIONS, INC. BANKING LAW JOURNAL ing is tainted by forgery or other fraud and requires the applicant to bear any costs attributable to fraudulent or forged documents: • Rule 1.08(b) states that an issuer is not responsible for the “accuracy, genuineness, or effect of any document presented under the standby.” • Rule 4.13 states that the issuer has no obligation to the applicant to ascertain the identity of any person making a presentation or any assignee of proceeds unless the standby requires presentation of an electronic record,78 • Rule 8.01(b) states that the applicant must indemnify the issuer against the consequences of the “fraud, forgery or illegal action” of others.79 If a credit is to be issued subject to ISP98, these provisions could be treated as independent obligations of the applicant (or independent limitations on the duties of the issuer) that could be used by an issuer to avoid limitations or restrictions on the applicant’s indemnification obligations negotiated in the applicant’s agreement with the issuer. UCP 600 does not contain a similar indemnification provision, but it does provide, in Art 34, that the issuer “assumes no liability or responsibility for…[the] genuineness [or] falsification of any document.” This clause is similar to ISP98 Rule 1.08(b) and might also operate, in a credit made subject to UCP 600, to end-run limitations on the applicant’s indemnification obligations under its agreement with the issuer. TRANSFERS OF CREDITS Letter of credit law generally distinguishes between the transfer of a credit and an assignment of proceeds payable under a credit. The former includes a transfer of the right to draw under the credit; the latter transfers only the right to receive payment under a credit when the beneficiary draws under the credit. Each of Article 5, UCP 600, and ISP98 provides that a credit is not transferable unless it so states.80 UCC 5-112 imposes no limit on the number of times a credit may be transferred, and does not set out procedures applicable to transfers, other than making credits non-transferable unless 128 Published in the February 2008 issue of The Banking Law Journal. Copyright ALEXeSOLUTIONS, INC. DRAFTING LETTERS OF CREDIT they state they are transferable. UCP 600 Art 38 has a similar requirement, goes on to provide detailed procedures for transfer, but permits only one transfer. This could create a trap for standby credits issued to trustees under long term debt instruments, because the identity of a trustee could change several times over the life of the debt issue. UCP 600 Art 38 also permits transfer of a transferable credit in whole or in part. It would be rare in the standby world to permit a credit to be transferred in part. Finally, UCP 600 Art 38(h) and (i) contain provisions relating to retained rights of the first beneficiary following a transfer to a second beneficiary that are confusing in the context of standby credits (although they make sense to those dealing regularly with commercial credits). For all these reasons, a transferable standby otherwise subject to UCP 600 probably should spell out the terms of permissible transfers, exclude other transfers, and take exception to the whole of UCP Art 38. ISP98 Rule 6.02 permits multiple transfers but prohibits partial transfers unless the underlying credit expressly provides otherwise — a structure more in tune with the standby credit market than UCP 600. Rule 6.03 gives the issuer significant ability to define the conditions applicable to a transfer, to the extent not otherwise specified in the standby, although any conditions beyond those expressly set forth in Rule 6.03 (limited to predictable transfer conditions) must be “reasonable.”81 In standby practice, the form of the credit is usually agreed in advance and the transfer provisions (if deemed necessary) are laid out in detail in the credit. But if a bank will be issuing multiple standby credits pursuant to a letter of credit facility where the scope and purpose of each credit may differ, the applicant should ensure that it retains some ability to tailor the transfer provisions of each credit to the purposes of the credit. Both ISP98 Rules 6.11 through 6.14 and UCC 5-113 make specific provision for transfers of the rights of a beneficiary under a credit by operation of law. UCP 600 contains no such provisions, and, as in the case of fraud or forgery, those matters would be decided under a UCP 600 credit by recourse to applicable law. UCC 5-114 and ISP98 Rules 6.06 - 6.10 also deal at some length with assignments of proceeds under a credit, and should be consulted at the time 129 Published in the February 2008 issue of The Banking Law Journal. Copyright ALEXeSOLUTIONS, INC. BANKING LAW JOURNAL of drafting of a credit if they are applicable to the credit and assignments of proceeds are expected to occur. By contrast, UCP 600 Art 39 simply refers assignment of proceeds issues to applicable law. LOST, STOLEN, MUTILATED, OR DESTROYED CREDITS It is common for the terms of a credit to require the return of the original credit instrument as a condition for drawing under the credit or as a condition to transfer of the credit. Moreover, even if the terms do not require a return of the original instrument, each of ISP98, UCP 600, and Article 5 requires, or can be construed to permit issuers to require, return of the original instrument as a condition to transfer. ISP98 Rule 6.03(b)(ii) expressly requires presentation of the original credit as a condition to transfer, and ISP98 Rule 3.12 states that the issuer is under no obligation to replace a lost, stolen, mutilated, or destroyed credit or to waive any requirement that the original of the credit be presented with any draw under the credit. UCP 600 Art 38 provides that “[a] bank is under no obligation to transfer a credit except to the extent and in the manner expressly consented to by that bank,” which clearly authorizes the issuer to impose a return requirement. Article 5 merely permits the issuer to impose conditions to transfer of a credit “reasonable under the circumstances” but one could not count on a court finding an issuer “unreasonable” in demanding the return of the original instrument as a condition to transfer.82 As a consequence, the beneficiary under a credit that is intended to be transferable, or under a credit that requires presentation of the original credit as a condition to draw, may fairly seek the issuer’s agreement to provisions comparable to customary provisions for the replacement of lost, stolen, mutilated, or destroyed securities. PARTIAL DRAWINGS AND MULTIPLE DRAWINGS; UCP 600 ISSUE FOR STANDBY CREDITS AVAILABLE IN INSTALLMENTS Article 5 contains no rules dealing with credits under which partial or 130 Published in the February 2008 issue of The Banking Law Journal. Copyright ALEXeSOLUTIONS, INC. DRAFTING LETTERS OF CREDIT multiple drawings may be made. ISP98 Rule 3.08 recognizes that a standby may provide for partial and multiple drawings, and sets forth certain rules that should be consulted if the credit will permit partial or multiple drawings and will be subject to ISP98. The UCP 600 situation is more complex, and, in one aspect, potentially troublesome. UCP 600 contemplates partial drawings (Art 31(a)) as well as multiple drawings (Art 32), but goes on in Art 32 to state that if drawings by instalments within given periods are stipulated in the credit and an instalment is not drawn within the period allowed for that instalment, then “the credit ceases to be available for that and any subsequent instalment.” A standby credit that is not a “direct pay” credit supporting, e.g., an owner’s liability to make periodic progress payments to a contractor or a lessee’s obligation to make payments to a lessor, might well fall under the rule of UCP 600 Art 32, resulting in the frustration of the legitimate business expectations of the applicant and the beneficiary. Accordingly, any credit subject to UCP 600 that provides for multiple payments must be drafted in a manner that eliminates any conflicting provisions of Art 32. ACCURATE RENDITION OF DOCUMENT FORMS ATTACHED TO A CREDIT OR DESCRIBED IN THE TEXT OF THE CREDIT UCP 600 and Article 5 are silent as to how accurate the rendition of an attached form must be, but ISP98 Rule 4.09 could surprise beneficiaries (or insufficiently cautious issuers). It provides (in great detail) that if the form attached is required to be presented in “exact” or “identical” form by the credit, it must be “exactly reproduced,” including typographical errors, punctuation, spacing and blank spaces, but if there is simply a reference to a document “in the form of ” an attachment to the credit, typographical and similar errors in the form that are apparent when read in context may be corrected and spacing may be adjusted. Beneficiaries will want to make sure that the magic words “exact” or “identical” are not used to describe documents the forms of which are incorporated in or attached to the credit.83 131 Published in the February 2008 issue of The Banking Law Journal. Copyright ALEXeSOLUTIONS, INC. BANKING LAW JOURNAL INDEMNIFICATION OF AND PAYMENT OF COSTS AND EXPENSES OF THE ISSUER BY THE APPLICANT Article 5 is silent as to the financial obligations of an applicant to the issuer. UCP 600 and ISP98 both contain provisions requiring the applicant to hold the issuer harmless for costs and expenses it incurs in the issuance and administration of the credit, and to indemnify the issuer for costs it incurs in compliance with foreign laws, although they do so in different ways and with different effects. UCP 600 Art 37(a) states that “[a] bank utilizing the services of another bank for the purpose of giving effect to the instructions of the applicant does so for the account and at the risk of the applicant,” and Art 37(c) states that “[a] bank instructing another bank to perform services is liable for any commissions, fees, costs or expenses…incurred by that bank in connection with its instructions.” The net effect seems to be that all costs and expenses of any bank in the chain of financial institutions incurred “in connection with its instructions” under a particular credit are first passed back to the issuing bank under Art 37(c) and then passed on to the applicant under Art 37(a). The only other provision of UCP 600 dealing overtly with the financial obligation of the applicant to the issuer is Art 37(d), which states that the applicant must indemnify the issuer against “all obligations and responsibilities imposed by foreign laws and usages.” An issuer can be expected, in adverse circumstances, to argue that this provision applies even if the credit specifies foreign law as the governing law, and even if the results of the application of foreign law do not differ materially from the application of domestic law. Overall, ISP98 reflects a significantly greater concern with the rights of the issuer against the applicant than does UCP 600. Initially, that might not seem to be the case, as the ISP98 provision that is parallel to UCP 600 Arts 37(a) and (c), Rule 8.02(a) provides only that the applicant “must pay the issuer’s charges and reimburse the issuer for any charges that the issuer is obligated to pay to persons nominated with the applicant’s consent to advise, confirm, honour, negotiate, transfer, or to issue a separate undertaking.” While similar to combined Art 37(a) and Art 37(c), Rule 8.02(a) is limited to the “charges” of other persons (which is undefined but seems most likely to mean stated or customary fees and similar items of nominated persons), 132 Published in the February 2008 issue of The Banking Law Journal. Copyright ALEXeSOLUTIONS, INC. DRAFTING LETTERS OF CREDIT and to persons nominated “with the applicant’s consent,” and thus is quite a bit narrower than the corresponding provisions of UCP 600. But Rule 8.01(b), the ISP98 indemnification provision, goes well beyond UCP 600 Art 37(d), providing that the applicant must indemnify the issuer for all claims (including attorney’s fees) arising out of “(i) the imposition of law or practice other than that chosen in the standby or applicable at the place of issuance; (ii) the fraud, forgery, or illegal action of others; or (iii) the issuer’s performance of the obligations of a confirmer that wrongfully dishonours a confirmation.” While clause (i) is somewhat narrower than the corresponding UCP 600 provision, because it excludes indemnification for foreign law if the standby designates foreign law, clauses (ii) and (iii) have no parallel in UCP 600. Moreover, Rule 8.01(c), which states that Rule 8.01 “supplements any applicable agreement, course of dealing, practice, custom or usage providing for reimbursement or indemnification on lesser or other grounds,” is clearly intended to make the Rule 8.01(b) indemnification obligations additional to any separate indemnification and expense reimbursement agreement negotiated by the issuer and the applicant. No such express statement is found in UCP 600. From the applicant’s perspective, however, more important than the question whether the credit utilizes UCP 600 or ISP98 indemnification and reimbursement provisions is the relationship between those provisions and the expansive indemnification and expense reimbursement provisions that will inevitably appear in the agreement between applicant and issuer providing for issuance of the credit. Those obligations will normally be more allencompassing than either UCP 600 or ISP98, so that the task for the applicant will be to make sure that the specific limitations and exclusions that the applicant might negotiate in the contractual indemnification and expense provisions are not inadvertently contradicted by the provisions of UCP 600 or ISP98 noted here. SALE OF PARTICIPATIONS BY AN ISSUER Article 5 and UCP 600 are silent as to syndications and participations, but Rule 10.02 of ISP98 could surprise an applicant. It permits an issuer 133 Published in the February 2008 issue of The Banking Law Journal. Copyright ALEXeSOLUTIONS, INC. BANKING LAW JOURNAL (unless otherwise agreed with the applicant) to sell participations in its reimbursement rights against the applicant, and to disclose “in confidence” information about the applicant to potential participants, all without the consent of or notice to the applicant. ELECTRONIC PRESENTATION OF DOCUMENTS ISP98 Rule 3.06(a) and (b) permit a document to be presented only in the medium specified in the credit; and if the credit does not specify a medium, the document must be presented as a paper document. Rule 3.06(c) specifies that a document is not a “paper document” if it is communicated by electronic means even if the issuer receiving it generates a paper document from it, thus excluding documents created from PDF files or facsimile transmitted to the issuer, and Rule 3.06(d) provides that if presentation by an “electronic medium” is indicated in the credit, the document must be presented as an “electronic record.” ISP98 Rule 1.09 contains an extensive definition of “electronic record,”84 and effectively limits the category to only those records that can be delivered through SWIFT or other similar systems capable of electronically verifying/authenticating the integrity of the document at the receiving end.85 On the other hand, Rule 3.06(a) seems to leave an issuer and a beneficiary free to agree on the medium in which a document may be presented, so a facsimile or PDF presentation should be permitted if specifically authorized by the credit.86 Article 5 uses the term “electronic” only in the definition of “record” in UCC 5-102(14), which is defined to mean “information that is inscribed on a tangible medium, or that is stored in an electronic or other medium and is retrievable in perceivable form.” Because the definition does not embody the authentication concept contained in ISP98, it seems that a fax or PDF file would constitute a “record.” But the Article 5 definition of “document” (which is what must be presented to draw under a credit) includes a “record” only if it is presented as a written medium, in a medium permitted by the credit, or by the “standard practice of financial institutions that regularly issue letters of credit.” While “standard practice” is of course a moving target, as of the fall of 2007 it does 134 Published in the February 2008 issue of The Banking Law Journal. Copyright ALEXeSOLUTIONS, INC. DRAFTING LETTERS OF CREDIT not appear to be standard practice to accept electronic documents (except perhaps under standbys with simple drawing requirements issued to responsible financial institutions and similar beneficiaries). Prudence thus indicates that any form of electronic presentation, such as facsimile or SWIFT should be authorized by the express terms of the credit. UCP 600 is silent as to electronic documents, using the term “electronic” only in Art 3 in reference to the authentication of signatures, and its treatment of “original documents” in Art 17(b) focuses on paper documents, reflecting UCP 600’s focus on trade finance, with its emphasis on bills of lading and other documents that are typically issued in tangible form. However, UCP 600 was published together with what is called the “Supplement to UCP 600 for Electronic Presentation.” This document was originally published by the International Chamber of Commerce in 2002 as a supplement to UCP 500 to facilitate the electronic presentation of documents under commercial credits, and seems to have been carried over with no significant changes to UCP 600. The scope of the supplement is beyond the scope of this article; the curious reader should consult the ICC’s Guide to the eUCP, by James Byrne and Dan Taylor.87 SUBROGATION While neither UCP 600 on ISP98 deals with rights of subrogation arising out of payments under credits or reimbursements of payments under credits, UCC 5-117 sets out such rights in considerable detail. Those rules are beyond the scope of this article, and their application in practice is complex. Worth noting here is the fact, relevant in the context of an insolvent issuer or applicant, that UCC 5-117(d) expressly provides that no such rights of subrogation arise until a payment or reimbursement has actually occurred, and that until such time no rights arise under UCC 5-117 that can form the basis of a claim, defense, or excuse.88 135 Published in the February 2008 issue of The Banking Law Journal. Copyright ALEXeSOLUTIONS, INC. BANKING LAW JOURNAL OTHER RULE SYSTEMS UN Convention on Independent Guarantees and Stand-by Letters of Credit (the “Convention”) The Convention, so far ratified by only a few countries (Belarus, Ecuador, El Salvador, Gabon, Kuwait, Liberia, Panama and Tunisia as of October 2007), is generally similar in substance to Article 5 and the UCP.89 The Convention came into effect in the late 1990s, but is little used. By its terms, it applies only to international independent guarantees90 and standby credits issued by an institution in a state that has ratified the Convention, or if choice-of-law rules operative in a proceeding involving a credit issued in another jurisdiction operate to invoke the laws of a ratifying state. It has the status of law where effective but by its terms it does not apply to an ordinary commercial credit unless the credit undertaking expressly makes it applicable, and it expressly permits a credit undertaking to opt out from the convention if it would otherwise be applicable. It also contains provisions dealing with the right of applicants to block payment under a credit for fraudrelated reasons that appear more favorable to applicants than the corresponding provisions of UCC 5-108.91 The Convention has seen little use and it is probably reasonable for beneficiaries to fear that, even without the applicant-favorable language of the Convention, courts of the jurisdictions that have ratified the Convention will not apply the independence principle as rigorously as would the courts of commercially developed jurisdictions, particularly if the applicant or issuer is a resident of such a jurisdiction and the beneficiary is a non-resident. Accordingly, it may be easier, if a transaction involves an issuer or a beneficiary based in a ratifying state or has such a connection to a ratifying state that the application of choice of law rules in another relevant jurisdiction may point to the laws of that ratifying state, to obtain the agreement of the relevant parties to the inclusion of a formal disclaimer of the application of the Convention rather than to spend time considering specific provisions of, or the likely jurisdiction of enforcement of, the Convention.92 136 Published in the February 2008 issue of The Banking Law Journal. Copyright ALEXeSOLUTIONS, INC. DRAFTING LETTERS OF CREDIT ICC Uniform Rules for Demand Guarantees In 1992, the ICC released its Uniform Rules for Demand Guarantees, ICC Publication No. 458 (the “URDG”). The “demand guarantee” described in the URDG is basically the same thing as the “independent guarantee” covered by the Convention, and thus is equivalent to a standby credit:93 the independence principle applies and payment is based solely upon review of documents presented against the requirements of the underlying instrument. According to one English commentator, the demand guarantee was primarily developed in the context of construction contracts and in international contracts for the sale of goods (in each case to safeguard the beneficiary against non-performance or late performance by a contractor or supplier), whereas standby credits constitute “an all-purpose financial support instrument embracing a much wider range of uses than the normal demand guarantee.”94 The origin of the 1992 URDG lies in the ICC’s 1978 Uniform Rules for Contract Guarantees. The 1978 rules were little used95 because they were not based on the independence principle but instead required as a condition to the beneficiary’s right to payment under a “contract guarantee” the submission of a judgment or arbitral award evidencing right to payment.96 An obligation issued under the 1978 rules was thus little better than an ordinary guaranty or a surety bond. By contrast, UCP 400, published in 1983, extended the coverage of the Uniform Customs and Practices to standby credits, which perhaps gave an incentive to their use in transactions in which custom might have dictated the use of a demand guarantee. With this background, the 1992 URDG can be seen as a somewhat belated attempt to create a set of rules in which demand guarantees would be placed on the same “independence” footing as standby credits subject to the UCP.97 NOTES A quick general introduction to the origin and basics of letters of credit may be found in Gao Xiang and Ross C. Buckley, The Unique Jurisprudence of Letters of Credit: Its Origin and Sources, 4 SAN DIEGO INT’L L. J. 91 (2003). 2 Standby credits were a U.S. invention, developed to allow banks to provide the functional equivalent of guarantees without violating regulatory restrictions on the 1 137 Published in the February 2008 issue of The Banking Law Journal. Copyright ALEXeSOLUTIONS, INC. BANKING LAW JOURNAL issuance of guarantees. To maintain the distinction from guarantees, they took the same form as commercial credits, with payment based solely on the presentation of documents, and the rights of the beneficiary independent of the contractual arrangements between the beneficiary of the credit and the party who caused the credit to be issued. A useful discussion of the nature of standby credits and the difference between a standby credit and a conventional guarantee or surety bond can be found in John F. Dolan, LETTERS OF CREDIT (A.S.Pratt, 4th Ed., 2007) (hereinafter “DOLAN”), at ¶1.05, pp 1-31. 3 Most standbys seem to fall into one of three general categories: those that secure payment due on the failure of a person to complete performance of an obligation, those that secure payment due on the occurrence of a financial default and those that provide for the payment of amounts coming due on debt instruments in lieu of payment by the obligor on the debt (so-called “direct pay” credits). There is one major practical difference between standby credits and commercial credits: the parties involved with a commercial credit generally expect that the credit will be drawn upon, but in the case of a standby credit (other than a direct pay credit), the parties expect (or at least hope) that the event triggering the right to draw is a contingency that will not occur. 4 All citations in this article to Article 5 or to sections thereof are to the New York version of Article 5. Keep in mind that the New York text is not identical to the 1995 Official Text of Revised Article 5. Significant changes appear (i) in UCC 5111, where New York dropped ¶(e) of the Official Text (providing for the mandatory award of attorney’s fees for the prevailing party in an action in which a remedy is sought under Article 5) and (ii) in UCC 5-108(e), where New York dropped the last two sentences of the Official Text: “Determination of the issuer’s observance of standard practice is a matter of interpretation for the court. The court shall offer the parties a reasonable opportunity to present evidence of the standard practice.” 5 See the discussion below. 6 UCP 600 is supplemented by International Chamber of Commerce Publication No. 681 (2007) entitled “International Standard Banking Practice for the Examination of Documents under Documentary Credits” (hereinafter “ISBP No. 681”), which updated a similar ICC-published companion to UCP 500. While ISBP No. 681 deals primarily with the examination of the kinds of documents customarily associated with commercial credits, it contains some principles of general application (one of which is discussed below), as well as some additional interpretative provisions of the kind contained in UCP 600 Art 3. 7 A “document,” in the letter of credit world, is an item required to be presented to draw under a credit. The extent to which these can be other than paper “documents” is briefly discussed below. 138 Published in the February 2008 issue of The Banking Law Journal. Copyright ALEXeSOLUTIONS, INC. DRAFTING LETTERS OF CREDIT The Uniform Customs and Practices first purported to cover standby credits in UCP 400, promulgated in 1983. 9 ISP98 is characterized by Professor Dolan as “different in form and subtly different in substance from other ICC publications in the realm of abstract undertaking law…. ISP98 [is] filled with detail, and no issuer, beneficiary or applicant should deal with a standby subject to these rules without studying them.” DOLAN, supra note 2, at ¶4.09(4), p 4-109. 10 This article uses “issuer” in a generic way, to mean the person issuing a credit. See below as to who may issue a credit. 11 UCC 5-103(d): “Rights and obligations of an issuer to a beneficiary or a nominated person under a letter of credit are independent of the existence, performance, or nonperformance of a contract or arrangement out of which the letter of credit arises or which underlies it, including contracts or arrangements between the issuer and the applicant and between the applicant and the beneficiary.” 12 UCP 600 Art 4(a): “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 of a bank to honour, 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. “A beneficiary can in no case avail itself of the contractual relationships existing between banks or between the applicant and the issuing bank.” UCP 600 Art 5: “Banks deal with documents and not with goods, services or performance to which the documents may relate.” 13 ISP98 Rule 1.06(c): “(c) Because a standby is independent, the enforceability of an issuer’s obligations under a standby does not depend on: (i) the issuer’s right or ability to obtain reimbursement from the applicant; (ii) the beneficiary’s right to obtain payment from the applicant; (iii) a reference in the standby to any reimbursement agreement or underlying transaction; or (iv) the issuer’s knowledge of performance or breach of any reimbursement agreement or underlying transaction.” ISP98 Rule 1.07: “An issuer’s obligations toward the beneficiary are not affected by the issuer’s rights and obligations toward the applicant under any applicable agreement, practice or law.” 14 Some of the pieces of paper may originate with the beneficiary but some may have to come from third parties, such as consulting engineer certificates, bills of lading or insurance certificates. 15 The relevant provisions of UCP 600 and ISP98 are as follows: “The Uniform Customs and Practice for Documentary Credits, 2007 Revision, ICC Publication no. 600 (“UCP”) are rules that apply to any documentary credit 8 139 Published in the February 2008 issue of The Banking Law Journal. Copyright ALEXeSOLUTIONS, INC. BANKING LAW JOURNAL (“credit”) (including, to the extent to which they may be applicable, any standby letter of credit) when the text of the credit expressly indicates that it is subject to these rules.” UCP 600 Art 1. “A standby letter of credit or other similar undertaking, however named or described, whether for domestic or international use, may be made subject to these Rules by express reference to them.” ISP98 Rule 1.01(b). 16 Technically, UCC 5-116(3) only gives priority to those provisions of UCP 600 or ISP98 that relate to the “liability of the issuer,” but because questions of whether the issuer did not pay when it should have paid, paid when it should not have, or should be enjoined from making payment dominate letter of credit litigation, the only safe assumption is that incorporation of UCP 600 or ISP98 will result in most if not all conflicts with Article 5 being resolved in favor of UCP 600 or ISP98, as the case may be, except for conflicts relating to the non-variable provisions of Article 5. 17 UCC 5-108(a) is not one of the provisions that is protected by UCC 5-103(c). 18 Exactly the same issue, of course, exists if the credit specifies ISP98 instead of UCP 600: UCC 5-116(3) would give the provisions of ISP98 priority over all inconsistent provisions of Article 5 other than the non-variable provisions. 19 See James E. Byrne, THE OFFICIAL COMMENTARY ON THE INTERNATIONAL STANDBY PRACTICES (Institute of International Banking Law and Practice 1998) (hereinafter, the “ISP COMMENTARY”), at Rule 1.04 Comment 4, pp 16-17. The Comment notes that this Rule does not operate to place the applicant in privity with parties other than the issuer. It only operates as a gloss on the relative rights of the issuer and the applicant. 20 For example, ISP98 Rule 1.04(vi) says that the applicant is bound if “it authorizes the issuance of the standby.” A “standby,” under Rule 1.01(d), is defined as a credit issued subject to ISP98. Has an applicant who has authorized the issuance of a credit without specifying in its agreement with the issuer whether it is subject to UCP 600 or ISP98 (or indeed without specifying whether it is subject to any body of supplemental rules) in fact “authorized the issuance of a standby” within the meaning of ISP98 if the issuer, on its own initiative, has elected to issue the standby subject to ISP98? 21 One caution is in order — although this article identifies a number of areas in which UCP 600 or ISP98 may be unfavorable to one party or another in a letter of credit transaction, parties should not blindly follow this as a checklist of changes that “ought” be made, but should rather consider their own needs, the likelihood of the issue arising, and the consequence to them of an adverse resolution of the issue. Eliminating the UCP 600 transfer restriction may be critical if the beneficiary is a bond trustee and the credit supports a long-term debt instrument, but may be unimportant if the beneficiary is a single purpose company that is the owner of a con- 140 Published in the February 2008 issue of The Banking Law Journal. Copyright ALEXeSOLUTIONS, INC. DRAFTING LETTERS OF CREDIT struction project where the contract will be performed over a relatively short period of time. 22 “…a bank or other person that issues a credit, but does not include an individual who makes an engagement for personal, family or household purposes.” 23 “…a definite undertaking that satisfies the requirements of Section 5-104 by an issuer to a beneficiary at the request or for the account of an applicant or, in the case of a financial institution, to itself or for its own account, to honor a documentary presentation by payment or delivery of an item of value.” 24 “1-102(3): The effect of provisions of this Act may be varied by agreement, except as otherwise provided in this Act and except that the obligations of good faith, diligence, reasonableness and care prescribed by this Act may not be disclaimed by agreement but the parties may by agreement determine the standards by which the performance of such obligations is to be measured if such standards are not manifestly unreasonable.” 25 See, e.g., Gao Xiang and Ross P. Buckley, The Development of the Fraud Rule in Letter of Credit Law: The Journey So Far and the Road Ahead, 23 U. PA. J. INT’L ECON. L. 663 (2002); Gao Xiang and Ross P. Buckley, A Comparative Analysis of the Standard of Fraud Required Under the Fraud Rule in Letter of Credit Law, 13 DUKE J. COMP. AND INT’L L. 293 (2003); and David J. Barru, How to Guarantee Contractor Performance On International Construction Projects: Comparing Surety Bonds with Bank Guarantees and Standby Letters of Credit, 37 GEO. WASH. INT’L L. REV. 51, 8292 (2005). 26 This will normally require appropriate governing law language in both the credit and in the issuance agreement between applicant and issuer, because the beneficiary normally cannot be said to be a party to any instrument other than the credit, and the applicant is not a party to the credit. 27 This may not be as simple as it seems. The beneficiary may demand a New York law credit, but if neither the issuer nor the applicant has any particular relation to New York, the courts of their respective jurisdictions may not be inclined to honor a New York choice of law in the reimbursement agreement. 28 See Dr. Jens Nielsen and Nicolai Nielsen, Standby Letters of Credit and the ISP 98: A European Perspective¸ 23 BANKING & FINANCE L. REV 163 (2001), at 203. This article, also available in what appears to be an earlier draft form at www.letterofcreditforum.com/node/11 (as of November 2007), outlines (among other things) a number of ways in which the authors believe ISP98 conflicts with German law. 29 UCC 5-116(a) here refers only to “banks,” although Article 5 elsewhere contemplates that an “issuer” is not limited to a bank or other financial institution. 30 The UCP 600 formulation is less applicant-friendly than the ISP98 formulation. Under the ISP98 version, the applicant’s indemnification obligation arises only if the 141 Published in the February 2008 issue of The Banking Law Journal. Copyright ALEXeSOLUTIONS, INC. BANKING LAW JOURNAL issuer incurs liabilities under foreign law other than the law chosen to govern the credit. However, the UCP 600 language can be interpreted to require the applicant to indemnify the issuer against foreign law liabilities without regard to the governing law stated in the credit — which could be a problem for an applicant if the credit is a UCP 600 credit, the credit is stated to be subject to New York law, and the issuer is not located in New York. This and other indemnification issues are discussed below. 31 See the ISP COMMENTARY, supra note 19, at Rule 1.11 Comment 10.a, p 60. 32 While this language appears in the context of a section focusing on the examination and honor or dishonor of a presentation by the beneficiary, there is nothing in the text or the Official Comments to limit paragraph (e) solely to situations arising in the course of document examination. 33 The Official Text of UCC 5-108(e) reads as follows: “An issuer shall observe standard practice of financial institutions that regularly issue letters of credit. Determination of the issuer’s observance of the standard practice is a matter of interpretation for the court. The court shall offer the parties a reasonable opportunity to present evidence of the standard practice.” The New York version eliminates the last two sentences, presumably to leave the question of what constitutes standard practice to the finder of fact in the case. (A subsidiary question posed by UCC 5-108(e) is whether the relevant time for measuring standard practice is at the time the credit was issued or at the time the disputed events occurred.) 34 See UCP 600 Art 2. 35 There is a potential practice trap here: Rule 2.03 requires the standby to state that it is not “issued” or not “enforceable.” Statements that the standby is not “available,” “effective” or “operative” do not have the same effect. 36 One way this could happen is when an applicant wants an unusual credit issued under the terms of a general letter of credit facility originally intended to cover only conventional trade credits. 37 While UCP 600 does not expressly incorporate ISBP No. 681, the two documents were issued in tandem and the introduction to UCP 600 makes it clear that the UCP 600 drafting group expected ISBP No. 681 to be authoritative within its scope. 38 One example: a proposed amendment that reduced the number of future drawings permitted under a standby credit supporting principal and interest payments on a debt instrument. A subsequent presentation for the next installment of principal and interest could comply fully with the terms of the credit as originally drafted and as modified, but provides no logical support for the conclusion that the beneficiary agreed with the amendment or, indeed, had even seen the proposed amendment. 39 In the context of commercial credits, amendments are frequently issued in final 142 Published in the February 2008 issue of The Banking Law Journal. Copyright ALEXeSOLUTIONS, INC. DRAFTING LETTERS OF CREDIT form through SWIFT, and hence are binding on the issuer from the time of transmission, which is prior to acceptance by the beneficiary. 40 See supra. 41 In the unusual case that a complicated amendment to a credit not subject to UCP 600 or ISP98 is being tendered to the beneficiary already executed by the issuer but without prior agreement of the parties on all of the terms of the amendment, it would of course be prudent to state in the document that partial consent is not permitted. 42 See the ISP Commentary, supra note 19, at Rule 2.06 Comment 10, p 84. 43 The intent here is to permit conditions such as “the Dow Jones index exceeds 10,000 at the close of business on the presentation date” or “the beneficiary has at least $X on deposit in account #Y maintained at the Z branch of the issuer.” See Rule 4.11(c)(iv). 44 Cf. DOLAN, supra note 2, at ¶4.06(2)(h), p 4-66 and at ¶6.04(7), pp 6-60 to 663. 45 The argument is as follows: UCC 5-108(g) says that non-documentary conditions contained in an undertaking constituting a letter of credit under UCC 5102(a)(10) are to be ignored. Paragraph (10) defines a letter of credit as an undertaking by an issuer to honor a “documentary presentation.” If the undertaking contains a material non-documentary condition, then perhaps it is not a “letter of credit” at all under the paragraph 10 definition, even if it is titled “Letter of Credit” and otherwise looks and smells like a credit. 46 It is not clear which approach is more favorable to beneficiaries. The stricter notification requirements of UCP 600 substitute the question of “when did the issuer decide to honor or dishonor” for the question of “what is a reasonable time to review and either honor or give notice of discrepancies,” and they limit the ability of the issuer of an about-to-expire credit to delay the notice of discrepancies until such time as re-presentation is difficult or impossible. On the other hand, the “reasonableness” requirement of the ISP98 time period probably ought to mean, notwithstanding Rule 5.01(a)(iv), that the issuer of an ISP98 credit cannot simply put a presentation aside and not review it until just prior to the end of the maximum review period. 47 In actual practice, many standby credits — particularly so-called “direct pay” credits supporting the timely payment of debt instruments — provide a much shorter period for examination and honor or dishonor. Periods of less than one working day are not uncommon in “direct pay” credits, where payment is typically due on presentation by the beneficiary of a one paragraph certificate as to the amount due and a sight draft for the amount due. 48 UCC 5-108(b)(3); UCP Art 16(c); ISP98 Rule 5.01(c). 49 This is commonly referred to as “preclusion.” See UCC 5-108(c); UCP 600 143 Published in the February 2008 issue of The Banking Law Journal. Copyright ALEXeSOLUTIONS, INC. BANKING LAW JOURNAL Art 16(c) and ISP98 Rule 5.02. 50 “Business day” is defined in ISP98 Rule 1.09 as “a day on which the place of business at which the relevant act is to be performed is regularly open.” 51 “Banking day” is defined in UCP 600 Art 2 as “a day on which a bank is regularly open at the place at which an act subject to these rules is to be performed.” 52 But note that the beneficiary, to be eligible for the benefit of Rule 3.14(a), will need to demonstrate that the presentation was not made “because of the closure.” A beneficiary could be asked to prove that the documents required for presentation were all in existence and in the hands of a messenger standing on the doorstep of the bank on the last day for presentation. 53 ISP98 Rule 3.14(b) provides that an issuer may authorize another reasonable place for presentation in the standby or in a communication received by the beneficiary if the place of presentation stated in the credit will be closed. 54 Dishonors for trivial inconsistencies appears to have been primarily, if not exclusively, a problem with commercial credits, rather than standby credits, as can be seen from the focus of new Art 14(e) and Art 14(f ), and the last sentence of new Art 14(j). 55 This seems to be a negative restatement of a consistency requirement, and in some future litigation will undoubtedly spur debate as to when an “inconsistency” is not a “conflict.” 56 Note that the specific document review standards of UCP 600 probably cannot be incorporated into ISP98 through the reference to “standard standby practice” under Rule 4.01(b). Rule 4.20(a) provides that “A document presented under a standby is to be examined in the context of standby practice under these Rules even if the document is of a type…for which the Uniform Customs and Practice for Documentary Credits contains detailed rules.” (Emphasis added.) 57 “An issuer or nominated person is required to examine documents for inconsistency with each other only to the extent provided in the standby.” 58 The ISP COMMENTARY notes that the consistency requirement may be more appropriate for straight commercial letters of credit covering payment for goods, where all of the submitted documents should be on their face applicable to the same identified goods. In a standby credit, the documents to be presented (if they involve more than a recitation that amounts are due under a debt instrument) may be only tangentially related to each other, and it would be difficult to determine what might be meant by an “inconsistency.” See the ISP COMMENTARY, supra note 19, at Rule 4.03 Comment 2, p 146. 59 See the discussion supra. Also, drafters of issuance agreements should remember that adjustments made in the credit to the applicability of UCP 600 or ISP98 that are intended to affect the applicant’s rights and liabilities may not bind the applicant unless also included or referred to in the issuance agreement. 144 Published in the February 2008 issue of The Banking Law Journal. Copyright ALEXeSOLUTIONS, INC. DRAFTING LETTERS OF CREDIT In addition, ISP98 Rule 3.04 contains extensive default rules as to how and where presentations should be made if the credit is silent or vague on this point. Best practice is to avoid the application of (or the need to interpret) these default rules by making sure the credit clearly indicates where, when, how and to whose attention presentation must be made. 61 For signed or otherwise authenticated documents, that makes sense, but what if a document requires evidence that the Dow Jones industrial index was over 10,000 on a particular day? Is there a difference between a photocopy of a page of the WSJ for that day, and the “original” newsprint page? Ambiguities like this are best avoided by specifying with precision the nature of the document to be provided in the terms of the credit when the “document” is intended to serve as evidence of an external event and not as the statement of the person issuing the document. 62 The UCP 600 authors may have meant “the credit” here, and not “the document.” 63 A presentation that does not properly identify the credit thus runs the risk of being dishonored because it is a late presentation. 64 See footnote 61. 65 This is important for applicants to understand. If there is any likelihood under an ISP98 credit that a third party document will be issued in a foreign language (because, for example, it is issued by a foreign government that will only issue documents in its native tongue) the credit should require as an additional document a certified translation of that document or it should be clear that the issuer will accept documents in the foreign language. 66 This is not necessarily the wording that a beneficiary would assume is appropriate in a “certificate of default.” 67 This Rule appears to be designed to eliminate the ability of a beneficiary or an applicant to claim that the issuer is guilty of an anticipatory breach of all of its obligations under the credit if one draw under a multiple draw credit is dishonored. Issuers, of course, are worried that the erroneous action of document examiners (who are generally clerical rather than managerial or legal personnel) could subject the bank to liability as though it had dishonored all subsequent draws. 68 There is a significant issue hidden here: Rule 3.10 states that the issuer does not have to notify the applicant of a presentation, so that the applicant may not find out that a draw has been made until the issuer presents to the applicant the documents constituting the presentation and demands reimbursement (or, more likely, notifies the applicant that it has debited the applicant’s account with the issuer by the amount of the draw). An applicant obtaining a standby credit in support, say, of a construction contract with complicated contract-related drawing conditions may want to provide for prompt delivery to the applicant of a copy of each presentation 60 145 Published in the February 2008 issue of The Banking Law Journal. Copyright ALEXeSOLUTIONS, INC. BANKING LAW JOURNAL received by the issuer. See the ISP COMMENTARY, supra note 19, at Rule 3.10 Comment 2, p 122, for an statement of the reasons an issuer might resist assuming such an obligation. 69 The issuer’s right not to accept a waiver presumably is based on a desire to avoid arguments between an issuer and an beneficiary as to whether the applicant’s waiver is sufficient to protect the issuer. 70 See ISP98 Rules 5.05 and 5.06. 71 However, the issuer may not waive Rules 4.04 and 4.05 if the substance of those Rules is contained in the credit itself. 72 The Rules waiveable under Rule 3.11 that are not summarized in the text generally deal with the process of submitting a presentation (e.g., how to identify the standby under which demand is made and where and to whom presentation is made). Waivers of these Rules are less likely to be of concern to applicants (other than an applicant yearning for any circumstance — even one irrelevant to the underlying business deal — that will cause the issuer to determine that a presentation is non-complying). 73 See also the discussion supra. 74 This article does not delve into the circumstances (some of them fascinatingly improbable sounding) in which courts have and have not elected to enjoin payments under credits in cases of fraud or forgery. For those who wish to know more about the development of this area of letter of credit law, good starting points are the articles cited in footnote 25 and DOLAN, supra note 2, at ¶7.04, pp 7-59 to 7-129. 75 The limitations are (1) a party adversely affected by the relief must be adequately protected against loss that it may suffer if the relief is granted, (2) on the basis of the information submitted to the court, the applicant is more likely than not to succeed under its claim of forgery or material fraud, (3) the person demanding honor is not protected under UCC 5-109(a)(1), and (4) the conditions entitling the applicant to injunctive relief under local law have been met. (There are additional limitations if the relief requested seeks to block payment under a draft accepted by or a deferred obligation incurred by, the issuer.) 76 Rule 1.06(c)(iv), which states that “the enforceability of an issuer’s obligations under a standby does not depend upon…the issuer’s knowledge of performance or breach of any reimbursement agreement or underlying transaction,” seems to be saying that the issuer must perform even if it knows of fraud. However, Rule 1.05 and the ISP COMMENTARY make it clear that applicable law outside of ISP98 (e.g., UCC 5-109 in a New York law credit) would govern the issuer’s right to withhold payment or the applicant’s right to enjoin payment in the case of fraud or forgery. See the ISP COMMENTARY, supra note 19, at Rule 1.05 Comments 1, 2 and 5, pp 19-21. 77 See Dolan, supra note 2, at ¶4.06(2)(e), pp 4-60 to 4-62. The argument, and 146 Published in the February 2008 issue of The Banking Law Journal. Copyright ALEXeSOLUTIONS, INC. DRAFTING LETTERS OF CREDIT Professor Dolan’s response, apply equally to UCP 600. The text of ¶4.06(2)(e) discusses various cases supporting and opposed to Dolan’s position; Dolan concludes that recent New York authority supports his view. 78 The exception to Rule 4.13 is made because under ISP98 an electronic record requires, by definition, authentication of the sender. See Rule 1.10. 79 The ISP COMMENTARY, supra note 19, makes it clear that the applicant is intended to bear the risk of double payment (see Rule 4.13 Comments 1 and 2, p 174 and Rule 8.01, Comment 7, p 270), justifying this position on the grounds that there are no generally-accepted procedures (other than through a SWIFT-type electronic presentation) through which banks can ascertain the identity or capacity of the presenter of documents. 80 UCC 5-112(a); UCP 600 Art 38(b); ISP98 Rule 6.02(a). The normal freedom of alienation of personal property is not applied to drawing rights under commercial or standby credits on the grounds that the applicant and the issuer are issuing the credit as a part of a known commercial relationship in which there is (usually) a significant element of trust that the beneficiary will not abuse the credit. See the ISP COMMENTARY, supra note 19, at Rule 6.02 Comment 2, p 232. 81 It is not clear how much significance the limitation to “reasonable” conditions may have. Rule 6.02(b)(iii) states that the issuer must “agree” to the transfer, without reference to conditions, which suggests that unless the terms of the credit clearly state that the issuer will transfer on the satisfaction of certain specified conditions, the mere inclusion of conditions to transfer leaves the issuer free to argue that transfer is still at the discretion of the issuer. 82 See UCC 5–112(b)(2). 83 The ISP COMMENTARY states that the “exact” or “identical” formulation should “not be lightly used by applicants or issuers nor lightly acceptable by beneficiaries.” See the ISP COMMENTARY, supra note 19, at Rule 4.09 Comment 7, p 164. 84 Rule 3.06(b) makes two exceptions to the general rule set forth above. If the credit requires only a demand for payment, (i) it is deemed to comply if presented by a beneficiary that is a SWIFT participant or a bank through SWIFT, tested telex, or other similar authenticated means, and (ii) the issuer may in its sole discretion elect to accept a non-paper demand (e.g., a fax or perhaps an e-mailed PDF file) from any other beneficiary. 85 Rule 1.09 requires that any “electronic record” must be capable of being authenticated and the definition of “authentication,” requires that it be possible to “assess the integrity” of the information in any “electronic record” to determine whether the “information has remained complete and unaltered.” Rule 3.06(c) makes it clear that a document communicated by electronic means (e.g., a fax or a PDF document) is not a paper document even if a paper document can be generated from it. 147 Published in the February 2008 issue of The Banking Law Journal. Copyright ALEXeSOLUTIONS, INC. BANKING LAW JOURNAL See the ISP COMMENTARY, supra note 19, at Rule 3.01 Comment 2, p 90. International Chamber of Commerce Publication No. 639 (November, 2002). 88 See Official Comment 2 to UCC 5-117: “Only one who has completed its performance in a letter of credit transaction can have a right to subrogation. For example, an issuer may not dishonor and then defend its dishonor or assert a setoff on the ground that it is subrogated to another person’s rights.” See DOLAN at ¶7.05, pp 7-135 ff, for a general discussion of subrogation issues in the context of letters of credit. 89 See DOLAN, supra note 2, at ¶4.01(4), pp 4-5 to 4-12, for a general discussion of the Convention. A significant difference is in Articles 19 and 20 of the Convention, which set forth, in much more detail than in UCC 5-109, the circumstances in which an issuer may dishonor on the ground of fraud and in which an applicant may seek to enjoin payment. 90 The term “independent guarantee” is typically applied to documents, identified as guarantees, issued by non-US banks under which payment is available solely on the delivery of required documents, and is not conditioned upon any proof that a third party obligation has not been performed. They are based on the same independence principle as, and are functionally equivalent to, standby credits. 91 See Articles 19 and 20 of the Convention. 92 But if this course is elected, the drafter should check with local counsel in the relevant ratifying state to make sure that the disclaimer will be accepted by the courts of that state if litigation seeking to apply the Convention is brought in that state. Countries have different rules regarding the legal hierarchy of ratified conventions and how to solve conflicts between conventions and domestic law. 93 Sometimes also called a “first demand guarantee” to emphasize the primary nature of the obligation. 94 Roy Goode, GUIDE TO THE ICC UNIFORM RULES FOR DEMAND GUARANTEES, International Chamber of Commerce, Publication No. 510, 1992 (hereinafter “URDG GUIDE”), at p 17. This guide appears to have been replaced by THE USER’S HANDBOOK TO THE URDG, International Chamber of Commerce Publication No 631 (2001). Because the URDG does not seem to be widely used, and is not used at all for instruments issued by US banks because of the regulatory limitations on the issuance by US banks of “guarantees,” this article does not address the substance of the URDG. 95 Roy Goode bluntly characterized them as a “failure.” URDG GUIDE, p 24. 96 At the time the 1978 rules were adopted, public attention had been focused on the risk of improper calls made under contract guarantees. 97 The URDG Guide notes that at the time the URDG was issued, it was assumed that issuers of standby credits would continue using the UCP, and that the URDG 86 87 148 Published in the February 2008 issue of The Banking Law Journal. Copyright ALEXeSOLUTIONS, INC. DRAFTING LETTERS OF CREDIT was of application only to demand guarantees. As a prediction of the future treatment of standby credits, this was wrong, because only a few years later the US banking industry begat ISP98 to differentiate standby credits from commercial credits. And as an assessment of the potential applicability of the URDG, it also seems wrong: the principles embedded in the UDRG would, for the most part, have worked satisfactorily for standbys as well, if the nomenclature had been broad enough to cover both demand guarantees and standbys (although the UDRG does impose a duty on issuers to act with reasonable care and in good faith that is lacking in ISP98). One has to suspect that the English and European drafters of the UDRG accepted its narrow scope as the price of keeping away from the drafting table the US bankers and lawyers who would have jumped into any drafting project that purported to deal with standby credits. 149 Published in the February 2008 issue of The Banking Law Journal. Copyright ALEXeSOLUTIONS, INC.
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