The International Chamber of Commerce (ICC) Uniform Customs and Practice for Documentary Credits (UCP) Publication No. 400 was the 1983 Revision in force as from 1 October 1984, and was then, the universally accepted and recognized set of rules governing letters of credit. This was the bankers’ “bible”, so to write. It was to be not only the guide line for banking associations and individual banks but this 1983 Revision was to help clarify some nebulous areas in the previous revision of 1974. In fact, it did precisely that. Yet, there were still some other areas where crafty opportunistic businessmen, who had studied the ICC 400, had just enough leeway to manipulate the system around this new 1983 revision.
Following are a few examples of such manipulations that occurred during that era through modalities of nuance and deception.
Excerpt from the ICC 400 (*):
Article 7
a. Credits may be either
i. revocable, or
ii. irrevocable
b. All credits, therefore, should clearly indicate whether they are revocable or irrevocable.
c.
In the absence of such indication the credit shall be deemed to be
revocable.
Article 8
A credit may be advised to a
beneficiary through another bank (the advising bank) without engagement on the
part of the advising bank, but that bank shall take reasonable care to check
the apparent authenticity of the credit which it advises.
Article 9
a. A revocable credit
may be amended or cancelled by the issuing bank at any moment and without prior
notice to the beneficiary.
COMMENT: During the 1980’s and as recently as January 1994 with the ICC 500 Revision in force as of that date, dishonest persons could issue a Documentary Letter of Credit (DLC) to an inexperienced or uninformed supplier (beneficiary) and purposely would not state whether it was revocable or irrevocable in the text of the credit. Therefore, it would be revocable in accordance with 7, c above. Once a shipment was enroute to the buyer (applicant) the buyer would request that his bank “revoke” or cancel the letter of credit unbeknown to the beneficiary.
When the beneficiary went to the bank to encash the DLC he was told that he credit had been revoked. The buyer might concoct a story that his clients had cancelled their contract to buy the merchandize and therefore, he would no longer want the shipment.
The supplier having already incurred the costs of transportation, perhaps $5-20,000 for one to four twenty or forty foot seagoing containers, would be willing to bargain with the buyer since he would incur an additional $5-20,000 if he had to return the shipment to himself.
The buyer would then ask the supplier to discount the transportation costs from the original contract invoice ($10-40,000 for the return transportation) otherwise the buyer would not accept the shipment.
In many instances, the supplier would be willing to negotiate with the buyer in order to save the transportation costs and thus saving the original contract in the process.
This was a clever ploy used by sophisticated and fraudulent buyers who would take advantage of the uninformed and inexperienced suppliers who were not knowledgeable of the ICC 400.
COMMENT: Another clever and dishonest scenario has been structured in the following manner by buyers who were knowledgeable of the following in the ICC 400 and interpretation of the section on Expiration Date and Presentation.
EXPIRATION DATE AND
PRESENTATION
Article 46
a. All credits must stipulate an expiry date for presentation of documents for payment, acceptance or negotiation.
Article 47
a. In addition to stipulating an expiry date for presentation of documents, every credit which calls for a transport document(s) should also stipulate a specified period of time after the date of issuance of the transport document(s) during which presentation of documents for payment, acceptance or negotiation must be made. If no such period of time is stipulated, banks will refuse documents presented to them later than 21 days after the date of issuance of the transport document(s). In every case, however, documents must be presented not later than the expiry date of the credit.
Some clever and corrupt businessmen who were knowledgeable of the ICC 400 oftentimes contrived the following scenario.
1 They knew of the Independence Rule (Articles 3, 4 and 6) which appears below.
2 They knew of the Rules on Expiration and Presentation (Articles 46 and 47).
They, the buyers, the issuers of the DLC, would sign a contract with their supplier, the beneficiary. The contract would state specifically that the supplier would not present his documents to the bank for payment until, say perhaps, 30 days after shipment had been made. The language in the DLC opened by the buyer would not address it and also remain silent on this point. Therefore, the documents that would be presented to the bank 30 days after the issuance of the shipping documents, would have exceeded the 21 days as stipulated in Article 47,a, and the bank would refuse payment on the DLC. Hence, the buyer now has in his possession the merchandize, legally his, albeit illegally obtained. He just duped his supplier.
The paying bank rightfully refused the transport documents as they were now stale, having exceeded the 21-day period.
The supplier’s side contract with
the buyer is irrelevant and non-applicable due to the Independence Rule.
Article 3
Credits, by their nature, are separate transactions from the sales or other contract(s) on which they may be based and banks are in no way concerned with or bound by such contract(s), even if any reference whatsoever to such contract(s) is included in the credit.
Article 4
In credit operations all parties concerned deal in documents, and not in goods, services and/or other performances to which the documents may relate.
Article 6
A beneficiary can in no case avail himself of the contractual relationships existing between the banks or between the applicant for the credit and the issuing bank.
EXPIRY
DATE AND PRESENTATION
Article
46
a.
All credits must stipulate an
expiry date for presentation of documents for payment, acceptance or
negotiation.
Article
47
a.
In addition to stipulating an
expiry date for presentation of documents, every credit which calls for a
transport document(s) should also stipulate a specified period of time after
the date of issuance of the transport document(s) during which presentation of
documents for payment, acceptance or negotiation must be made. If no such period of time is stipulated,
banks will refuse documents presented to them later than 21 days
after the date of issuance of the transport documents(s). In every case, however, documents must be
presented not later than the expiry date of the credit.
b.
For the purpose of these articles,
the date of issuance of a transport document(s) will be deemed to be:
i.
in the case of a transport
document evidencing dispatch, or taking in charge, or receipt of goods for
shipment by a mode of transport other than by air – the date of issuance
indicated on the transport document or the date of the reception stamp thereon
whichever is the later.
COMMENT: The following scheme, although somewhat
complicated, has been applied and perpetrated in Saudi Arabia. It deals with the reading and interpretation
of transport documents within the scope of DLC as referenced in the ICC 400.
The reference is as follows:
DOCUMENTS
Article 22
a.
All instructions for the issuance
of credits and the credits themselves and, where applicable, all instructions
for amendments thereto and the amendments themselves, must state precisely the
document(s) against which payment, acceptance or negotiation is to be made.
Unless a credit calling for a transport
document stipulates as such document a marine bill of lading (ocean bill of
lading or a bill of lading covering carriage by sea), or a post receipt or
certificate of posting:
a. banks will, unless otherwise stipulated in the credit, accept a transport document which:
b. Unless otherwise stipulated in the credit, banks will reject a document which:
i. indicates that it is subject to a charter party, and/or
ii indicates that the carrying vessel is propelled by sail only, and/or
Article 28
a. In the case of carriage by sea or by more than one mode of transport but including carriage by sea, banks will refuse a transport document stating that the goods are or will be loaded on deck, unless specifically authorized in the credit.
COMMENT: This trick or scheme would evolve into something like this.
The buyer (account party) in Saudi Arabia would request of the supplier (beneficiary) to have the merchandize drop shipped in Bahrain or the United Arab Emirates (UAE). His contrived story would state that some of his customers live in Bahrain or the UAE and he would deliver some of the supplies to them there, personally. He would arrange for the remainder of the shipment to Saudi by himself.
The buyer’s DLC clearly stated that the shipment would have
Saudi as its final destination.
The buyer would arrange for the shipment to be taken by Dhow (an Arabian ship propelled by sails only, somewhat similar in appearance to a Chinese Junk) across the Arabian Gulf. He would alert his bank in Saudi of two factors:
1 The goods would be loaded/unloaded “on deck” from one vessel to the other (which is prohibited by Article 28, a).
2 The final leg of the journey across the Arabian Gulf would be by Dhow (which would be in violation of the terms of the DLC and therefore the paying bank would have to reject the transportation documents: Articles 25,c and 26, c).
The purpose for this manipulation was to put the buyer in a strong negotiating position with the supplier. And, in order to straighten out this problem, because he now had the shipment in his possession and the supplier (beneficiary) could not present the DLC for payment, he usually politely demanded a significant discount.
This would be in breech of Articles 25,c, 26,c and 28,a as indicated above and the paying bank would reject the transport documents.
Even though the supplier and buyer had a contractual agreement to drop ship the supplies to Bahrain or the UAE, the Independence Rule protected the buyer in his scheme and simultaneously allowed the bank to reject the transport documents.
COMMENT: A similar type of fraud and deception was applied to Standby Letters of Credit (SLC).
For example, an individual (applicant) would borrow or take out a loan from an uninformed entity. He would guarantee repayment after a certain prescribed term, say perhaps, in 12 months. He would have his bank issue a SLC guaranteeing the repayment. As in the above example, the borrower would have the bank issue the SLC which would not state whether it was revocable or irrevocable, thus rendering it revocable. A short time after the SLC was issued he would instruct his bank to revoke or cancel the credit without informing the beneficiary as per Article 7,c above.
At the time specified in the SLC for the beneficiary to present the drafts attached in the SLC to the bank because the applicant had defaulted he would then be informed that the SLC had been revoked.
There was little or no recourse by
the beneficiary to collect from the bank or from the borrower even though he
had a contract with the borrower (Independence Rule, above).
EXAMPLE
FIVE
COMMENT: Another
clever act of deception with Standby Letters of Credit is as follows.
First, one must understand the
definition of a Notation Credit. (The UCC S.5-108(1) states: “A credit which
specifies that any person purchasing or paying drafts drawn or demands for
payment made under it must note the amount of the draft or demand on the letter
or advice of credit is a “notation credit”.)
With this understanding, the
concept of a notation credit is that partial drawings are permitted under the
credit. It contains the provision for the recording on the credit specific and
separate amounts paid under the credit and allows for the remaining amount to
be paid.
It is essential for a provision
for partial drawings be included in Standby Letters of Credit. With this provision allowing beneficiaries
to make partial draws, if the account party makes payments outside the credit
that are in sum less than the total amount owed, the beneficiary can still make
draws for the remaining unpaid balance.
Here is the example of an act of
deception by crafty individuals.
Let’s say a standby letter of
credit is issued and partial payments are not permitted. The credit is for
$100,000 and requires for the beneficiary to submit a statement upon
presentment that the account party has failed to pay the total amount of
$100,000 due.
Here is the deception: The account
party makes certain payments directly to the beneficiary outside the credit,
say in the amounts of $5,000 and $10,000. Having accepted these sums from the
account party the beneficiary cannot meet the requirement of submitting a
statement for payment of the total amount due of $100,000 since the account
party has already made partial payments outside the credit.
EXAMPLE SIX
COMMENT: The Independence
Rule cited in Example Two, above, is sometime combined with the Strict
Compliance Rule. Although the Independence
Rule (ICC400, articles 3,4 and 6) appears in the ICC400, the Strict
Compliance Rule is a standard that comes down to us from federal jurisdictions
and state courts.
The Uniform Commercial Code (UCC)
5-114 (1), which is also law, states, “An issuer must honor a draft or demand
for payment which complies with the terms of the relevant credit regardless of
whether the goods or documents conform to the underlying contract for sale or
other contract between the customer and the beneficiary…”.
The Strict Compliance Rule is that
the beneficiary must make presentment in strict compliance with the terms and
conditions of the credit. According to
H. Harfield, a leading expert and pioneer in letter of credit law declared, “In
letter of credit transactions, the parties deal in written representations and
not in facts.” And, a classic statement attributed to a Lord Sumner, “There is
no room for documents which are almost the same, or which will do just as well.
Business could not proceed securely on any other lines.” An American court also
stated, “Compliance with the terms of a letter of credit is not like pitching
horseshoes. No points are awarded for being close.”
Here is a typical scenario with a
breech of Strict Compliance.
The account party (the buyer of
materials) agrees with the beneficiary
(the seller) that he would prepay the inland transportation (freight)
charges once the shipment arrived in the jurisdiction of the buyer.
The letter of credit would clearly
state that the beneficiary (shipper) had to present certificates showing
freight charges were paid up to the destination of the buyer. This he could not
demonstrate because the account party had prepaid for the inland
transportation.
Strict Compliance of the letter of
credit had been breached and the paying bank would be under no obligation to
honor the letter of credit since the freight forwarder could not provide
documents indicating the shipper had paid him for the inland transportation.
EXAMPLE SEVEN
COMMENT: With A
Negotiation Credit the beneficiary is allowed to negotiate to third parties his
right to payment under the letter of credit through the purchase by the third
party of the draft or other document of demand cited in the
letter of credit.
This is the key to the deception.
A letter of credit is not a negotiable
instrument. The draft for payment under
the credit usually is.
Following is a typical example of
a negotiation clause:
We agree with the drawers, endorsers, and bona
fide holders of drafts drawn under and in agreement with the terms of this
letter or credit that such drafts should be duly honored upon
presentation and delivery of documents as specified.
The crafty and deceitful
beneficiary would sell his letter of credit, (which is a
non-negotiable instrument) to a third party when the letter of credit had no
provision stating that it was transferable.
What he was not selling were the drafts to the credit.
EXAMPLE EIGHT
COMMENT: The issuance of a Standby Letter of Credit with extrinsic
facts or conditions was another ploy of deceitful businessmen.
Relevant to the Independence
Rule and Strict Compliance Rule is well-contrived language stating that
payments on a Standby Letter of Credit would be contingent upon extrinsic
facts. Such as: “… funds would be available to pay the beneficiary after they
have been successfully collected from the sale of equipment or derived from
proceeds received from another contract.”
The important paragraph in the
letter of credit would read something to the effect:
“This is your authorization to draw a draft
for payment of proceeds which have been collected by Mr. XYZ, account party,
from the sale of equipment on behalf of Mr. ABC, beneficiary. Funds drawn from
this letter of credit shall be limited to only those funds received by Mr. XYX,
account party, from the sale of equipment that belongs to Mr. ABC, beneficiary,
with the provision allowing for the deduction of any outstanding liens.”
This language implies two
extrinsic factors, one, that the draft is for the payment of proceeds that have
been collected when the equipment was sold, and two, the equipment was sold on
behalf of the beneficiary.
As we understand from the Independence
Clause that the credit must stand-alone and not be conditioned upon any
side agreements, non-documentary extrinsic facts are also not
permitted in proper letters of credit.
_________________
(*) The Uniform Customs and Practice for Documentary Credits ICC 400 is published by the International Chamber of Commerce, 38, Cours Albert 1, 75008 Paris, France.