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Bank Collections,Trade Finance and Letters of Credit

Bank Collections,Trade Finance and Letters of Credit

Chapter 7

© 2002 West/ Thomson Learning

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Protection in SalesProtection in Sales

Contract-trade terms, clauses Insurance Bills of Exchange Letters of Credit

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Bills of Exchange or Draft: Negotiable Instrument

Bills of Exchange or Draft: Negotiable Instrument

Draft (or Bill of Exchange) “order to pay” issued by seller time draft or sight draft

Requirements for draft: unconditional written order Addressed from one person to another Signed by person giving it Requiring that person addressed by it pay on

demand or on future date Specified sum of money Pay to order of bearer or of specified person

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TerminologyTerminology

Seller = drawer and payee Buyer or buyer’s bank =

drawee

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Negotiation of Order InstrumentNegotiation of Order Instrument

Negotiation: transfer of instrument from one party to another Supported by payment of

value Holder takes legal rights

Requirements for Negotiation: Endorsement (by signature) Delivery

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Acceptance of Drafts

Drafts can be accepted by buyer, creating a trade acceptance Buyer agrees to pay unconditionally at the time

stated on the draft Buyer accepts by marking “accepted” and

signing Accepted draft returned to seller; can sell at

discount or hold to maturity Banker’s acceptance: bank agrees to pay draft

Banker’s acceptance is a negotiable instrument Can be used as flexible short-term financing

instrument

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Holder in due course: Special ProtectionHolder in due course: Special Protection

Have a negotiable instrument (draft or acceptance)

Taken for value In good faith Without notice of dishonor or

overdue Without notice of alteration or

unauthorized signature

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Letter of CreditLetter of Credit

Documentary L/C Issuing Bank (Buyer’s bank), account

party (Buyer), beneficiary (seller) Bank promises to pay the

beneficiary’s draft upon presentation of the specified documents

Security: bank’s promise to pay is better than buyer’s

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Letter of Credit: LawLetter of Credit: Law

Art. 5 UCC Uniform Customs & Practice (UCP)

incorporated into L/C UCC – Art. 5 – defers to UCP: UCC not

applicable to extent UCC is in conflict with UCP

“eUCP” – rules for electronic transmission, adopted in 2002

NYS law: UCP, not UCC, is applicable to L/C’s

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The Documentary Sale with a Letter of CreditThe Documentary Sale with a Letter of Credit

Exporter/Beneficiary

(seller)

ImporterAccount Party

(Buyer)

Issuing Bank Advising, Confirming,

orNegotiating Banks

Sales ContractCIF Port of DestinationCAD Irrevocable L/C

A

A. Sales contract calls for L/CB. Application for L/C

B

C

C

C. L/C forwarded to beneficiary through advising bank

D

D. Documents prepared according to L/C -- goods shipped

E

EE

E. Documents negotiated for payment against sight draft through negotiating or confirming bank

F

F. Payment after documents checked for discrepencies

FF

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Maurice O’Meara v. National Park Bank (NYC.A. 1925)Maurice O’Meara v. National Park Bank (NYC.A. 1925)

Facts: NPB issued letter of credit to R (beneficiary) at request of SH to cover delivery of newsprint.

R presented invoice and draft to NPB NPB refused payment because it could not test strength of

paper During this time the price of newsprint dropped over

$20,000 R transferred right to collect to O’Meara.

Issue: Did NPB have the right to refuse to pay on the L/C despite presentation of the proper documents in order to ensure paper was the proper weight?

Decision: No. The bank’s obligation is to pay when presented with the documents called for in the letter of credit.

Contract btwn buyer and seller is separate from bank’s obligation on L/C

Buyer still has a separate right of action against the seller for breach of contract.

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Sztejn v. J. Henry Schroder Banking(NY Sup. Ct. 1941)

Sztejn v. J. Henry Schroder Banking(NY Sup. Ct. 1941)

Facts: S contracts to buy hog bristles from T Bank opens L/C with seller as beneficiary T ships boxes of cow hair and rubbish T presents documents to bank for payment S brings suit to block bank from paying

Issue: When there is active fraud, may court enjoin bank from paying on irrevocable L/C?

Decision: Yes, where there is credible evidence of active fraud on seller’s part before bank has paid on L/C, court may enjoin payment.

Contract between buyer and seller is separate from L/C

Bank paying L/C before getting notice of fraud is protected if exercised reasonable diligence before paying

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Legal Issues of Bank Payment on L/C

UK position: narrows Sztejn v. J. Henry Schroder rule United City Merchants v. Royal Bank : General

Rule is that confirming banks are not permitted to refuse a demand for payment when the documents comply with the L/C

Fraud by third party doesn’t constitute fraud in the transaction to allow bank to deny payment

UCC s. 5-114: bank may honor draft despite notification from buyer of fraud, but court may enjoin payment NY: UCC doesn’t apply to L/C’s California: courts hold no injunction against

payment

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Courtauld’s v. North Carolina Nat. Bank (4th Cir. 1975)Courtauld’s v. North Carolina Nat. Bank (4th Cir. 1975)

Facts: NCNB opened L/C for buyer (A) with seller (C), as beneficiary; L/C stated “100% acrylic yarn.”

C presented invoice stating “imported acrylic yarn” and packing list “100% acrylic.” Bank refused to pay on L/C

In the meantime the buyer went bankrupt C sued NCNB for payment; trial court held for C NCNB appealed.

Issue: Was NCNB’s refusal to pay on L/C in violation of UCP and state law?

Decision: No; reverse trial court decision Reasons: Description of goods on invoice did not match that

on L/C NCNB entitled to insist on strict compliance Defect in invoice not cured by correct description in

packing list NCNB need only treat documents marked “invoice” as

invoice; no duty to examine collateral documents;

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Liability of confirming banksLiability of confirming banks

Why have a confirming bank? Concern about credit of issuing bank Currency restrictions Protect seller against issuing bank’s

credit risk Confirming bank is liable on the L/C

Entitled to reimbursement by issuing bank on presentation of documents

Bears risk of issuing bank’s or buyer’s credit failure

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Standby Letters of CreditStandby Letters of Credit

Used as performance guaranty Issued in favor of buyer Beneficiary need only present

statement that default has occurred to collect

For protection of seller, should require independent confirmation of default from third party

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Am. Bell v. Islamic Rep. Of Iran (S.D.N.Y. 1979)

Facts: AB entered into contract with I for consulting and equipment

Iran paid AB $38 million down payment Contract gave Iran right to demand return of down

payment at any time for any reason AB arranged standby L/C with Man. Bank to benefit of

Iranian bank Islamic revolution forces AB to suspend operations in Iran AB brings suit to enjoin Man. Bank from paying on L/C

Issue: Will enjoin bank from paying on standby L/C? Decision: No. AB negotiated standby L/C terms with “eyes

open” “One who reaps the rewards of commercial arrangements

must also accept its burdens.” Man. Bank faces loss of credibility, and possibly more AB had other remedies available

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L/C’s & e-Commerce eUCP – adopted 2002

eUCP rules apply when both parties agree when electronically transmitting documents

Rules address: Format of e-documents Authentification and digital signatures Transmission errors Manner of presentation

SWIFT system: private, high-speed system among banks

Bolero Project: replace paper-based system with electronic transmissions

Identrus – founded to secure digital identities and signatures

Will e-commerce system reduce errors?

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CountertradeCountertrade

Transactions involving exchange of goods rather than monetary payment 30% of world trade Exchange controls or currency

restrictions Counterpurchase Barter Buyback

Pepsi Cola and Stolichnaya example Risks involved?

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Review of Contract NegotiationReview of Contract Negotiation

Identify goals Set terms, negotiate conscious of

responsibilities and price accordingly Delineate contract to manage risk Use of samples Make sure language reflects your

agreement Inspect L/C for problems (60-80%

have errors) Remember rule of strict compliance