CHAPTER 7 Bank Collections, Trade Finance, and Letters of Credit

1. CHAPTER 7 Bank Collections, Trade Finance,and Letters of Credit

2. The Bill of Exchange • A Bill of Exchange (English) is a negotiable instrument that contains: • Unconditional order in writing. • From one person to another. • Signed by the person giving it. • To pay on demand or at a certain time. • Fixed sum of money. • To the ORDER or BEARER.

3. Negotiation and Transfer of Negotiable Instruments • Negotiation is the transfer of an instrument from one party to another (the holder) who takes legal rights in the instrument. • Indorsement. • Delivery.

4. Documentary Draft and the Bank Collection Process • Act as a substitute for money. • Act as a financing or credit device.

5. Documentary Draft and theBank Collection Process • Drafts can be accepted by buyer creating a trade acceptance. • Buyer agrees to pay unconditionally at the time stated on the draft. • Banker’s acceptance= bank agrees to pay= negotiable instrument. • Documentary collections is similar to a C.O.D. transaction. • The SWIFT System  (The Bolero Project).

6. Documentary Drafts Used in Trade Finance • Time Draft. • Banker’s Acceptances and Acceptance Financing. • Credit Risk in Trade Finance Programs. • Credit Risk in Acceptance Financing: Rights of Holder in Due Course 

7. Holder in Due Course • 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.

8. Credit Risks in Factoring Accounts Receivable: Rights of the Assignee • Seller assigns rights to collect to assignee or factor. • Does Assignee have the same rights as a holder in due course?

9. Letter of Credit • Documentary Letter of Credit. • Issuing Bank (Buyer’s bank), account party (Buyer), beneficiary (seller). • Bank promises to pay the beneficiary’s draft upon presentation of the specified documents. • Bank’s promise to pay is better than buyer’s.

10. The Documentary Sale with a Letter of Credit D A Sales ContractCIF Port of DestinationCAD Irrevocable LOC B F C F E E C E F A. Sales contract calls for LOC B. Application for LOC C. LOC forwarded to beneficiary through advising bank D. Documents prepared according to LOC -- goods shipped E. Documents negotiated for payment against sight draft through negotiating or confirming bank F. Payment after documents checked for discrepencies SHIP / VESSEL ImporterAccount Party(Buyer) Exporter/Beneficiary(seller) Advising, Confirming,orNegotiating Banks Issuing Bank

11. Law Applicable to Letters of Credit • Art. 5 UCC. • Uniform Customs & Practice (UCP) incorporated into LOC. • NY law states UCP not UCC is applicable. • Presumed Irrevocable. • The LOC is independent of the sales contract between the buyer and seller 

12. Independence: Maurice O’Meara v. National Park Bank of New York • NPB issued letter of credit to Ronconi (beneficiary) at request of Sun Herald to cover a delivery of newsprint. Ronconi presents invoice and draft to bank, but bank refused because it could not test strength of paper. During this time the price of newsprint dropped over $20,000. Ronconi transferred their right to collect to O’Meara.

13. Independence: Maurice O’Meara v. National ParkBank of New York • Issue: Was was bank correct under the law to refuse to pay on the letter of credit despite presentation of the proper documents because it wanted to assure itself that the paper was the proper weight? • Holding: No, the bank wan not correct. The bank’s obligation is to pay when presented with the documents called for in the letter of credit.

14. Independence: Maurice O’Meara v. National ParkBank of New York • The contract between the buyer and seller is separate from the obligation of the bank on the letter of credit. The buyer still has a separate right of action against the seller for breach of contract.

15. Following a Letter of Credit Transaction • Buyer’s Application and Contract with the Issuing Bank. • It is up to the buyer to apply for a letter of credit from a bank. • LOC contains instructions, terms, and condition to release the money. • Buyer’s application for credit is a contract between the buyer and the bank. • Complies with UCP.

16. Following a Letter of Credit Transaction • Seller’s Compliance with the Letter of Credit. • Seller must read the terms and conditions of the LOC very carefully before shipment or manufacturing of product. • Is the LOC accurate? Does it reflect the terms and conditions of the sales contract?

17. Following a Letter of Credit Transaction • Complying Presentation: delivery of seller’s documents and draft to the nominated bank or directly to the issuing bank. Contains: • All the required documents, • Within the time frame allowed and prior to expiry of the credit, • With no discrepancies, and • Which complies with all other terms of the LOC.

18. Following a Letter of Credit Transaction • Examination of Documents and Discrepancies. • UCP allows up to five banking days to inspect. • Commercial Invoice: required by buyers, banks, and customs authorities. • Bill of Lading: must be “on board.” • Insurance Policy (plus 10%). • Certificates of Analysis or Inspection.

19. Strict Compliance: Courtalds N.A. v. North Carolina National Bank • Bank opened letter of credit for buyer Adastra with Courtald’s, seller, as beneficiary. The LOC covered “100% acrylic yarn.” Seller presented documents with invoice “imported acrylic yarn” as well as a packing list “100% acrylic.”

20. Strict Compliance: Courtalds N.A. v. North Carolina National Bank • Bank refused to pay. In the meantime the buyer went into bankruptcy. Lower court holds for seller and the bank appealed. • Issue: Did the bank violate the UCP and the state law in insisting on strict compliance with the letter of credit and refusing to pay the seller upon presentation of the documents.

21. Strict Compliance: Courtalds N.A. v. North Carolina National Bank • No, the bank was correct in refusing to pay when the documents did not match the letter of credit. “There is no room for documents which are almost the same or which will do just as well.”

22. The UCP 600 Rule • Changes to UCP in 2007 indicate move to modified strict compliance rule. • Functional standard of compliance (used by courts in United States and some European countries). • What about ethical issues in LOC?

23. Procedures for Dishonor of LOC • Bank must follow procedure or face “issuer preclusion” and will be prevented from asserting the documents are discrepant. • Ask purchaser if wants to waive discrepancies? • Bank must give notice no later 7 banking days after receipt of the documents.

24. Enjoining Banks from Purchasing LOC in Cases of Fraud • Sztejn v. J. Henry Schroder Banking Corp. • Plaintiff contracts to buy hog bristles. Bank opens letter of credit with seller as beneficiary. Seller fills boxes with cow hair and rubbish and presents bank with documents for payment. Buyer brings this action to block bank from payment.

25. Enjoining Banks from Purchasing LOC in Cases of Fraud • Issue: When the there is active fraud, may a court enjoin a bank from payment on an irrevocable letter of credit? • Yes, although the contract between buyer and seller is separate, where there is credible evidence of active fraud on the seller’s part before the bank has paid on the LOC, the court may enjoin payment.

26. BUT.. • Confirming banks are not permitted to refuse a demand for payment when the documents comply with the LOC. • United City Merchants v. Royal Bank of Canada. • Under English view, fraud by a third party does not constitute fraud in the transaction. There was no evidence here of fraud by the beneficiary or knowledge of fraud.

27. Confirmed Letters of Credit • Why needed?

28. Standby Letters of Credit: Middle East • Why? Performance guaranty. • American Bell International, Inc. v. Islamic Republic of Iran. • Issue: Will the court enjoin the bank from paying 30 million on the standby letter of credit to Iran which was callable “at any time and for any reason”. • Holding: No. Bell negotiated this standby letter of credit under those terms with its eyes open

29. Standby Letters of Credit: Middle East • “One who reaps the rewards of commercial arrangements must also accept its burdens.” • The court also noted that the bank had other remedies available.

30. Other Specialized Uses for LOC • Transferable Credits. • Red Clauses in Credits. • Revolving and Evergreen Credits. • Back-to-Back Letter of Credit Financing.

31. eUCP • 2002 International Chamber of Commerce extends UCP to electronic documents

32. LOC in Trade Finance Programs • AID Financing. • Eximbank Financing: largest U.S. export financing agency. Can provide guarantees on loans made by commercial banks, and insurance on credit to foreign customers. • Commodity Credit Corporation. • Foreign Credit Insurance Association.

33. Conclusion: Review • 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 LOC for problems (60-80% have errors) • Remember rule of strict compliance.