and Bank Demand Guarantees Crafting Credit Instruments for Domestic and International Financing Transactions

Transcription

1 Presenting a live 90 minute webinar with interactive Q&A Letters of Credit, Stand by Letters and Bank Demand Guarantees Crafting Credit Instruments for Domestic and International Financing Transactions TUESDAY, DECEMBER 20, pm Eastern 12pm Central 11am Mountain 10am Pacific Today s faculty features: Kevin J. Connolly, Shareholder, Anderson Kill & Olick, New York Isaac E. Druker, Shareholder, Anderson Kill & Olick, New York The audio portion of the conference may be accessed via the telephone or by using your computer's speakers. Please refer to the instructions ed to registrants for additional information. If you have any questions, please contact Customer Service at ext. 10.

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5 Strafford Publications Webinar December 20, :00 pm-2:30 pm LETTERS OF CREDIT AND OTHER FIRST DEMAND PAYMENT INSTRUMENTS

6 Your Speakers Kevin J. Connolly, Esq. (212) kill Isaac E. Druker, Esq. (212)

7 Disclaimer The views expressed by the participants in this program are not those of the participants employers, their clients, or any other organization. The opinions expressed do not constitute legal advice, or risk management advice. The views discussed are for educational purposes only, and provided d only for use during this session

8 Origins Lombard Bankers of 15 th Century Italy laid the foundations of the first international banking system. A merchant could deposit bullion in Rome, travel to Adrianopolis, in the shadow of Istanbul, and draw his money from a correspondent in order to fund the caravan

9 Circular Letter of Credit Very closely related to the Lombard Credit Enables an agent to have access to funds while far away from home base Protects against theft Facilitates accounting Rarely seen today but was common 25 years ago

10 Payment Letter of Credit Workhorse of international trade Quintessential documentary sale Deals with documents, not goods Payment is made by buyer s bank upon tender of conforming documents Itemized on the Letter of Credit

11 Documentary Collection Notice that nothing in the cycle addresses where the goods are Documentary sales are different from other sales but still covered in the UCC, CISG and other regimes

12 The Documents Theletterofcredit specifies what documents must be presented in order to get paid Invoice Bill of Lading Draft Letter of Credit Others

13 The Documents Unless the credit specifies otherwise, the bill of lading must be clean A bill of lading or other transport document that takes exception for damaged containers or like evidence that the contents have been tainted is not clean Banks do not accept a document package with transport documents so noted unless the credit expressly stipulates the notations that are permitted

14 Others? In a documentary sale, the parties deal in documents not goods Documentary sale needs to provide reasonable assurances that the goods will actually arrive Cargo Inspection Certificates are frequently required to prevent receiving a containerful of sawdust Crime insurance may be needed for a complete solution to the shipment risk

15 Conforming Documents Proof of insurance is not required unless specified in the letter of credit Incorporation of contract term by reference does not affect draws under the L/C L/C transaction is based on the DOCUMENTS and critically the four corners of the L/C

16 Commercial Letter of Credit Serves to identify an L/C that is expected to serve as the payment facility for the contract Identifies the bearer as a financially-responsible party recognized as such by correspondent banks at the remote location The Seller in such a transaction can discount the bill of exchange for cash more readily

17 Commercial Letter of Credit Commercial paper backed by a letter of credit can be discounted more readily Letters of Credit are fundamental to the forfaiting f market

18 The Great Depression led to the enactment in the United States of the Glass-Steagall Act. This prohibited commercial banks from selling insurance or underwriting securities, prohibited investment banks from accepting demand deposits or selling insurance, and kept insurance companies out of banking Standby?

19 Standby? The anti-underwriting clauses also prohibited commercial banks from guaranteeing the obligations of unrelated parties The surety industry could not fill the gap because surety bonds are not pay now fight later documents

20 Letter of Credit Primary Independent Payable promptly First Demand Instrument Also known as suicide standby Payment made upon simple demand No proof of default or amount owed Not even a declaration of default is needed Bond (Surety Bond) Accessory Co-extensiveness Payable upon decree of tribunal (not prompt) Suretyship is implied if instrument provides for payment upon obligor s default Effektivklausen Documentary guaranty requires submission of third-party certifications such as court decree or arbitral award, but there is great inconsistency of nomenclature US standby L/C is termed documentary because it entails the presentation of at least a draft, but the L/C is a independent undertaking to pay, accept or negotiate

21 Standby? Within a few years after the enactment of Glass- Steagall, commercial banks had found a way around dthe strictures ti t of the statute They issued letters of credit that provided that no draws could be made absent a default by the account party under some other obligation

22 Governing Code Standby letters of credit began with a problem: they are square pegs in round holes The Uniform Customs and Practices for Documentary Credits were for years employed as the governing regime for standbys

23 UCP 600 The Uniform Customs and Practices perform admirably in their intended bailiwick: international payments for documentary sales The UCP lacks provisions for the distinctive features of a standby The UCP-credit still represents the basal form of L/C Much of the L/C jargon finds its roots in the documentary credit

24 UCP 600 Credit means an irrevocable, definite undertaking of the issuer to honor a presentation Honor means For a sight credit, by making payment For a deferred credit, to incur the bank s own obligation and to pay the same at maturity For an acceptance credit, to accept a bill of exchange or draft drawn by the beneficiary and to pay the acceptance at maturity

25 UCP 600: Jargon Advising Nomination Advising bank issues formal notice of the issuance of the credit by another bank Serves to make L/Cs drawn and payable abroad more manageable but the advising bank is not liable to make payment Advising bank often acts as intermediary Confirming In addition to advising of the credit, the confirming bank adds its own obligation to the credit Banks at which the credit may be presented Not all nominated banks are advising or confirming banks but advising/confirming i i banks are nominated Negotiation Nominated banks make the credit available by purchasing the draft(s) and making the proceeds available to the beneficiary Negotiation is limited to nominated banks unless the credit is issued payable through any bank

26 UCP 600 Jargon Presentation Delivery of documents under a credit Made at issuing or nominated bank (including advising or confirming banks) Bank has a limited time in which to examine the presented documents for compliance Complying Presentation is a presentation that Is in accordance with the terms of the credit Is in accordance with the rules of the governing regime (e.g., UCP 600) Complies with standard international banking practice

27 UCP 600: Jargon Independence The right of the beneficiary to payment does not depend on the contract t under which the L/C was issued Neither the beneficiary nor the bank may look to the underlying contract The obligation to pay does not depend on the right or practical ability of the issuing bank to reimbursement However, the issuer s right to reimbursement depends on the compliance of the documents to the requirements of the credit, UCP and standard practices

28 UCP 600: Jargon Documentary Banks deal with documents and not with goods, services or performance to which the documents relate The letter of credit should state within its four corners all of the elements of a complying presentation Issuing banks are cautioned to resist attempts by applicants to incorporate a contract or other document into the L/C Irrevocable A credit is irrevocable and need not say so expressly

29 UCP 600: Required Terms Credit must state the bank(s) with which it is available or that it is available at any bank Credit must state whether it is available by sight payment, deferred e ed payment, acceptance or negotiation Credit must state an expiry date for presentation If the bank is closed on the date when the credit expires, presentation on the next tbanking day is timely

30 Excuse Expiration of the L/C is If the bank is closed a complete defense to due to force majeure, payment and if paid neither the issuing nor notwithstanding the any confirming bank is expiry, the bank lacks a obligated to pay right to reimbursement If the L/C expired while under the UCP the bank was closed It may have contracted due to Acts of God, for a right to charge the riots, civil commotion, applicant for erroneous insurrection, war, payments and such clauses call for close scrutiny terrorism, strikes or lockouts, the bank must not honor, accept or negotiate the L/C

31 Transfer Issuing bank has no obligation to recognize a transfer of the credit to a new or additional beneficiary unless it has consented to the transfer Any fees must be paid by or for the first beneficiary before transfer Transferred credit must accurately reflect the credit (including confirmation, if any) except: Amount, including any unit price The expiry date Latest shipment date or agreed period for shipment

32 Transfer Beneficiary s right to If the deal between the assign proceeds of the beneficiaries calls for the L/C is not impaired by first beneficiary to present restrictions on transfer of the draft and remit the the credit itself Transfer may be partial The transfer would recite the reduction or curtailment of the amounts available Issuer remains liable for the balance of the credit which remains available to the first beneficiary second beneficiary s account, but first beneficiary does not do so or makes a non- conforming presentation ti that is not corrected upon first demand, second beneficiary can present its own draft and issuer is exonerated as to the first beneficiary

33 ISP 98 The International Standby Practices Edition was commissioned i by the ICC to fix the problems caused by US banks continued insistence on using the UCP to govern standby credits

34 ISP 98 ISP 98 does not Govern power or authority to issue standbys Formal requirements (statute of frauds) Defenses based on fraud, abuse or similar matters Likeacommercial credit, a standby is a definite undertaking that is irrevocable, documentary and binding when issued Likeacommercial credit, a standby can be advised or confirmed by banks in the beneficiary s locale

35 ISP 98 Like a commercial credit, a standby is independent d and the rights and defenses of the parties do not depend on issuer s right to receive reimbursement the beneficiary s right to receive payment pursuant to the contract reference to any other document in the standby or even the issuer s actual knowledge that there has been a breach (or performance) of the underlying contract or reimbursement agreement It is an absolute commitment to perform Acceptance Sight Payment Deferred Payment The issuer is not a guarantor and is not liable for the performance or breach of the underlying agreement Accuracy, genuineness or effect of any document presented under the standby the acts or omissions of others, even if those others are selected and instructed by the issuer Issuer is not required to conform to any law other than the law of the place of presentment

36 ISP 98 Standby letters of credit The standby should specify generally require that the the medium of presentment beneficiary draw a bill of If no medium is specified, exchange and present it with then paper documents must a certificate by the be presented beneficiary Certificates might declare that an event of default had occurred under the value transaction and other conditions (notice, lapse of time) entitling beneficiary to draw More modern practice is for beneficiary simply to certify that it is entitled to present the draft under the standby However, if the standby is payable on simple demand and the beneficiary is a bank of S.W.I.F.T. participant, the presentment may be made by S.W.I.F.T., tested telex, or other similar authenticated means Issuer may always permit electronic presentment t in its discretion

37 ISP 98 Standby letters of credit The standby should specify generally require that the the medium of presentment beneficiary draw a bill of If no medium is specified, exchange and present it with then paper documents must a certificate by the be presented beneficiary Certificates might declare that an event of default had occurred under the value transaction and other conditions (notice, lapse of time) entitling beneficiary to draw More modern practice is for beneficiary simply to certify that it is entitled to present the draft under the standby However, if the standby is payable on simple demand and the beneficiary is a bank of S.W.I.F.T. participant, the presentment may be made by S.W.I.F.T., tested telex, or other similar authenticated means Issuer may always permit electronic presentment t in its discretion

38 ISP 98 Examination Extraneous documents are those not required by the standby Following a presentation, the issuer (or confirming bank) must examine the documents for conformity to the standby Examination is limited to ascertaining whether the presentation satisfies the requirements set out in the standby Non-documentary condition in the standby are disregarded These don t have to be examined They shall be disregarded for purposes of determining whether the presentation conforms to the standby Consistency is not part of the examination unless the standby provides otherwise

39 ISP 98 No formalities required Unless the standby (notarization, requires the presentation officialization, witnesses) of an electronic record, unless stipulated in the issuer owes applicant no standby If formalities are required, issuer is not required to vet the authenticity of the indicia of notarization etc. Apparent compliance is sufficient to authorize payment duty to ascertain the identity of the person making the presentation But note that if the standby requires the presentation ti of a bill of exchange, the issuer is bound by the law of negotiable instruments to make payment only to a holder

40 ISP 98: Legal Documents Unlike the situation with Issuer s s examination is commercial credits, a limited to the apparent standby is not good order of the transmuted into an documents accessory surety bond Issuers should examine by requirements for their Financial court decrees, arbitral Institution Bonds to see awards, governmentissued documents and have for defending the like against claims that the what insurance they nonconformity of the presentation was patent

41 ISP 98: Examination Standard A document presented The UCP requires strict under a standby is to be compliance with the terms examined in the context of of the credit standby practice under these Rules even if the document is of a type (such as a commercial invoice, transport documents, insurance documents or the like) for which the Uniform Customs and Practices for Documentary Credits contains detailed rules Issuer of a commercial credit makes payment as the applicant s agent Agent who does not strictly comply with his principal s instructions is not entitled to reimbursement for expenditures made

42 Demand Guaranties The Uniform Rules for Undertaking is given Demand Guaranties, ICC Document 458, defines these as an undertaking to pay money upon a presentation of a written demand for payment in accordance with the terms of fthe undertaking Other documents (architect s certificate, judgment or arbitral award) specified in the Guaranty either at request of the Principal and under its liability or At the request of a bank or insurance company (the Instructing Party ) acting on behalf of the Instructing Party s own client, which is also a Principal The Guaranty is independent on the same terms as discussed for letters of credit

43 Demand Guaranties Like an L/C or standby, a guarantee should specify: The Principal The Beneficiary The Guarantor The underlying value transaction that calls for the Guaranty Maximum amount payable and currency in which payable Expiry Date or Expiry Event Terms for demanding payment Any provisions for reduction of the guarantee amount

44 Demand Guaranties Examination standard: Guarantor shall exercise due care to ascertain whether the documents presented appear to conform to the term of the guaranty Essentially the same standard as applies under ISP98 Counterguaranties When an Instructing Bank requests a confirming bank to issue its guaranty for the account of the principal, it generally issues a credit to the confirming bank stipulating the amounts the Instructing Bank will reimburse to the confirming bank, and on what terms and conditions

45 Counterguaranties The counterguaranty is In other markets, implied when the counterguaranties are instructing bank requests used to allocate risks of the confirming bank to non-completion and establish a guaranty for our account If a formal credit is issued, the Instructing Bank does so for the principal s account in order to establish its right to reimbursement from the Principal payment Instead of retaining 10% of progress payments, developers in the Middle East will release the entire contract sum in exchange for a counterguaranty from the contractor for 10% of the price of the work

46 Counterguaranties The contractor s guaranty is almost always a counterguaranty because the developer generally furnishes a bank guaranty covering payments to the contractors Other layers of (counter)guaranties come into play when mobilization payments mean that the owner has laid out more money than the work is actually worth The objective then becomes figuring i out how far ahead the contractor really is and providing for a bank guaranty to cover that difference Bank guaranties are often used as a functional substitute for performance bonds Fundamental difference: performance bonds are written for the full amount of the contract Bank guaranties or L/Cs for that amount would be prohibitively expensive Owner/Developer must be more proactive because it can t sit back and make the surety pay for the mess

47 Types of Bank Guaranties Very similar to surety bond products Tender Guaranties correspond to Bid Bonds in US parlance Generally payable on First Demand Performance Guaranties pays an owner if a contractor has not, not timely, not completely or not properly per-formed its contract Typically written for 5% to 10% of the contract sum Retention Guaranties Instead of retaining 10% of each progress payment, Owner pays 100% of the value of the work each payment and the contractor furnishes a guaranty to substitute for retention Maintenance and Warranty Guaranties Functionally similar to the Performance Guaranty but covers post-completion defects only Generally written for much less than a corresponding performance guaranty Repayment/Advance Payment Guaranties Instead of being concerned with a credit to cover the difference between the cost of the work and its reasonable value, a contractor could deliver a guaranty for the performance of Work for which the Owner has made advance mobilization payments

48 Types of Bank Guaranties Anything that can be Bank guaranties are done with a standby often required as can be accomplished security for food with a properly-drafted exporters in Europe bank guaranty, including provision of security for a lease, purchase & sale agreement Bank Guaranties are accepted as security for the payment of import duties throughout the EC Exporters are charged an amount intended to recoup the government subsidies on the production of their foods When exporting foods, the exporters typically provide the customs collectors with bank guaranties for the amounts being recouped

49 Fraud The whole idea behind Nonetheless, the rule these instruments is has grown up that fraud their absolute nature may be sufficient to If a seller of goods inspire a court to enjoin falsely certifies that he an issuer from making has shipped the goods payment or to enjoin covered by the buyer s the beneficiary from letter of credit, he most presenting a draft likely l can secure There is a great deal to payment under the L/C be said about long before Buyer fraud.so much that realizes that he has we re not going there been had today. Fraud needs its own program