Letters of Credit, Stand by Letters and Bank Demand

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Letters of Credit Stand by Letters Letters of Credit, Stand‐by Letters and Bank Demand GuaranteesCrafting Credit Instruments for Domestic and International Financing Transactions

Today’s faculty features:

1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific

TUESDAY, DECEMBER 20, 2011

Today s faculty features:

Kevin J. Connolly, Shareholder, Anderson Kill & Olick, New York

Isaac E. Druker, Shareholder, Anderson Kill & Olick, New York

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Strafford Publications WebinarDecember 20 2011December 20, 20111:00 pm-2:30 pm

LETTERS OF CREDIT AND OTHER FIRST DEMAND

PAYMENT INSTRUMENTSPAYMENT INSTRUMENTS

Your SpeakersYour Speakers

Kevin J Connolly EsqKevin J. Connolly, Esq.(212) 278-1471

k ll @ d [email protected]

Isaac E. Druker, Esq.(212) 278-1475( )

[email protected]

6 980292.1©2011 Anderson Kill & Olick, P.C.

All Rights Reserved.

DisclaimerDisclaimerThe views expressed by the participantsThe views expressed by the participants in this program are not those of the participants’ employers, their clients, orparticipants 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

l d id d l fpurposes only, and provided only for use during this session.



OriginsOrigins• Lombard Bankers of

15th Century Italy laid the foundations of the first international b ki tbanking system.

• A merchant could deposit bullion in Rome, travel to Adrianopolis intravel to Adrianopolis, in the shadow of Istanbul, and draw his money from a correspondent infrom a correspondent in order to fund the caravan



Circular Letter of CreditCircular Letter of Credit• Very closely related toVery closely related to

the Lombard Credit• Enables an agent to

have access to fundshave access to funds while far away from home base

• Protects against theft• Protects against theft• Facilitates accounting• Rarely seen today but

was common 25 years ago



Payment Letter of CreditPayment Letter of Credit• Workhorse ofWorkhorse of

international trade• Quintessential

d t ldocumentary sale– Deals with documents,

not goods– Payment is made by

buyer’s bank upon tender of conforming documents

– Itemized on the Letter of Credit



Documentary CollectionDocumentary Collection• Notice that nothingNotice that nothing

in the cycle addresses where th dthe goods are

• Documentary sales are differentsales are different from other sales but still covered in the UCC, CISG and other regimes



The DocumentsThe Documents• The letter of creditThe letter of credit

specifies what documents must be

t d i dpresented in order to get paid– InvoiceInvoice– Bill of Lading– Draft– Letter of Credit– Others



The DocumentsThe Documents• Unless the credit specifies p

otherwise, the bill of lading must be “clean”

• A bill of lading or other “transport document” thattransport document that takes exception for damaged containers or like evidence that the contents have been tainted is not cleantainted is not clean

• Banks do not accept a document package with transport documents so noted unless the creditnoted unless the credit expressly stipulates the notations that are permitted.



Others?Others?• In a documentary sale, the y

parties deal in documents not goods

• Documentary sale needs to provide reasonableprovide reasonable assurances that the goods will actually arrive

• Cargo Inspection Certificates are frequently required toare frequently required to prevent receiving a containerful of sawdust

• Crime insurance may be needed for a completeneeded for a complete solution to the shipment risk



Conforming DocumentsConforming Documents• Proof of insurance is

t i d lnot required unless specified in the letter of creditI ti f• Incorporation of contract term by reference does not affect draws under theaffect draws under the L/C

• L/C transaction is based on the DOCUMENTSon the DOCUMENTS and critically the four corners of the L/C



Commercial Letter of CreditCommercial Letter of Credit• Serves to identify an L/C y

that is expected to serve as the payment facility for the contract

• Identifies the bearer as a• Identifies the bearer as a financially-responsible party recognized as such by correspondent banks y pat the remote location

• The Seller in such a transaction can discount the bill of exchange forthe bill of exchange for cash more readily



Commercial Letter of CreditCommercial Letter of Credit• Commercial paper• Commercial paper

backed by a letter of credit can be discounted more readily

• Letters of Credit are fundamental to the f f iti k tforfaiting market



Standby?Standby?• The Great Depression led

to the enactment in theto the enactment in the United States of the Glass-Steagall Act.

• This prohibited pcommercial banks from selling insurance or underwriting securities, prohibited investmentprohibited investment banks from accepting demand deposits or selling insurance, and k t i ikept insurance companies out of banking



Standby?Standby?• The anti-underwritingThe anti underwriting

clauses also prohibited commercial banks from guaranteeing the obligations of unrelated partiesp

• The surety industry could not fill the gap because surety bonds because su ety bo dsare not “pay now—fight later” documents



Letter of Credit Bond (Surety Bond)• Accessory• Primary

• Independent• Payable promptly

• Accessory• Co-extensiveness• Payable upon decree of tribunal

(not prompt)• Payable promptly• “First Demand”

Instrument

• Suretyship is implied if instrument provides for payment upon obligor’s default

– Effektivklausen

– Also known as “suicide standby”

– Payment made upon

• Documentary guaranty requires submission of third-party certifications such as court decree or arbitral award, but Payment made upon

simple demand• No proof of default or

amount owed

there is great inconsistency of nomenclature

• US standby L/C is termed “documentary” because it entails

• Not even a declaration of default is needed

ythe presentation of at least a draft, but the L/C is a independent undertaking to pay, accept or negotiate



Standby?Standby?• Within a few years after y

the enactment of Glass-Steagall, commercial banks had found a way

d th t i t faround the strictures of the statute

• They issued letters of credit that provided thatcredit that provided that no draws could be made absent a default by the account partyby the account party under some other obligation



Governing CodeGoverning Code• Standby letters ofStandby letters of

credit began with a problem: they are square pegs in round q p gholes

• The Uniform Customs and Practices forand Practices for Documentary Credits were for years employed as the e p oyed as t egoverning regime for standbys.



UCP 600UCP 600• The Uniform Customs and PracticesThe Uniform Customs and Practices

perform admirably in their intended bailiwick: international payments for documentary salesdocumentary sales

• The UCP lacks provisions for the distinctive features of a standbydistinctive 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



UCP 600UCP 600• “Credit” means an irrevocable definite• Credit means an irrevocable, definite

undertaking of the issuer to “honor” a presentationp

• “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 maturityFor an acceptance credit to accept a bill of– For an acceptance credit, to accept a bill of exchange or draft drawn by the beneficiary and to pay the acceptance at maturity



UCP 600: JargonUCP 600: Jargon• Advising • Nominationg

– Advising bank issues formal notice of the issuance of the credit by another bank

– Serves to make L/Cs drawn d bl b d

– Banks at which the credit may be presented

– Not all nominated banks are advising or confirming banks b t d i i / fi i b kand payable abroad more

manageable but the advising bank is not liable to make payment

– Advising bank often acts as

but advising/confirming banks are nominated

• Negotiation– Nominated banks make the

dit il bl b h iAdvising bank often acts as intermediary

• Confirming– In addition to “advising” of the

credit, the confirming bank

credit available by purchasing the draft(s) and making the proceeds available to the beneficiary

– Negotiation is limited tocredit, the confirming bank adds its own obligation to the credit

Negotiation is limited to nominated banks unless the credit is issued payable through “any bank”



UCP 600 JargonUCP 600 Jargon• Presentation • ComplyingPresentation

– Delivery of documents under a creditMade at issuing or

Complying Presentation is a presentation that

I i d ith– Made at issuing or nominated bank (including advising or confirming banks)

– Is in accordance with the terms of the credit

– Is in accordance with th l f thconfirming banks)

– Bank has a limited time in which to examine the presented

the rules of the governing regime (e.g., UCP 600)Complies ithexamine the presented

documents for compliance

– Complies with standard international banking practice



UCP 600: JargonUCP 600: Jargon• Independence – The obligation to pay Independence

– The right of the beneficiary to payment does not depend on th t t d

g p ydoes not depend on the right or practical ability of the issuing bank to reimbursementthe contract under

which the L/C was issued

– Neither the beneficiary

bank to reimbursement– However, the issuer’s

right to reimbursement depends on the – Neither the beneficiary

nor the bank may look to the underlying contract

pcompliance of the documents to the requirements of the credit UCP andcredit, UCP and standard practices



UCP 600: JargonUCP 600: Jargon• Documentary – Issuing banks are Documentary

– Banks deal with documents and not with goods, services or

gcautioned to resist attempts by applicants to incorporate a contract or otherg

performance to which the documents relate

– The letter of credit should state within its

contract or other document into the L/C

• IrrevocableA dit ishould state within its

four corners all of the elements of a complying presentation

– A credit is irrevocable and need not say so expresslyexpressly



UCP 600: Required TermsUCP 600: Required Terms• Credit must state the • Credit must state an• Credit must state the

bank(s) with which it is available or that it is

• Credit must state an expiry date for presentation

available at any bank• Credit must state

h th it i il bl

p• If the bank is closed

on the date when whether it is available by sight payment, deferred payment,

the credit expires, presentation on the

t b ki d ide e ed pay e t,acceptance or negotiation

next banking day is timely



ExcuseExcuse• Expiration of the L/C is • If the bank is closed p

a complete defense to payment and if paid notwithstanding the

i th b k l k

due to force majeure, neither the issuing nor any confirming bank is bli t d texpiry, the bank lacks a

right to reimbursement under the UCPIt may have contracted

obligated to pay• If the L/C expired while

the bank was closed due to Acts of God• It may have contracted

for a right to charge the applicant for erroneous payments and such

due to Acts of God, riots, civil commotion, insurrection, war, terrorism strikes orpayments and such

clauses call for close scrutiny

terrorism, strikes or lockouts, the bank must not honor, accept or negotiate the L/C



g

TransferTransfer• Issuing bank has no • Transferred creditIssuing bank has no

obligation to recognize a transfer of the credit to a new

Transferred credit must accurately reflect the credit (including

or additional beneficiary unless it has consented to the

( gconfirmation, if any) except:– Amount, including any

transfer• Any fees must be paid

by or for the first

, g yunit price

– The expiry date– Latest shipment date by o o t e st

beneficiary before transfer

or agreed period for shipment



TransferTransfer• Beneficiary’s right to • If the deal between the y g

assign proceeds of the L/C is not impaired by restrictions on transfer of the credit itself

beneficiaries calls for the first beneficiary to present the draft and remit the second beneficiary’sthe credit itself

• Transfer may be partial• The transfer would recite

the reduction or

second beneficiary s account, but first beneficiary does not do so or makes a non-

f i t tithe reduction or curtailment of the amounts available

• Issuer remains liable for th b l f th dit

conforming presentation that is not corrected “upon first demand,” second beneficiary can present its

the balance of the credit which remains available to the first beneficiary

y pown draft and issuer is exonerated as to the first beneficiary



ISP 98ISP 98• The InternationalThe International

Standby Practices-1998 Edition was

i i d bcommissioned by the ICC to fix the problems caused byproblems caused by US banks’ continued insistence on using th UCP tthe UCP to govern standby credits



ISP 98ISP 98• ISP 98 does not • Like a commercialISP 98 does not

– Govern power or authority to issue standbys

Like a commercial credit, a standby is a definite undertaking that is irrevocable,

– Formal requirements (statute of frauds)

– Defenses based on fraud abuse or similar

,documentary and binding when issued

• Like a commercialfraud, abuse or similar matters

Like a commercial credit, a standby can be advised or confirmed by banks in co ed by ba sthe beneficiary’s locale



ISP 98ISP 98• Like a commercial credit, a

t db i “i d d t” d• It is an “absolute” commitment

t fstandby is “independent” and the rights and defenses of the parties do not depend on

– issuer’s right to receive reimbursement

to perform– Acceptance– Sight Payment– Deferred Payment

Th i i t treimbursement– the beneficiary’s right to receive

payment pursuant to the contract– reference to any other document

in the standbyth i ’ t l

• The issuer is not a guarantor and is not liable for

– the performance or breach of the underlying agreement

– Accuracy genuineness or effect– or even the issuer’s actual knowledge that there has been a breach (or performance) of the underlying contract or reimbursement 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 issuerand instructed by the issuer

• Issuer is not required to conform to any law other than the law of the place of presentment



ISP 98ISP 98• Standby letters of credit • The standby should specify y

generally require that the beneficiary draw a bill of exchange and present it with a certificate by the

y p ythe medium of presentment– If no medium is specified,

then paper documents must be presented

fbeneficiary– Certificates might declare that

an event of default had occurred under the “value transaction” and other

– 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 bytransaction and other

conditions (notice, lapse of time) entitling beneficiary to draw

– More modern practice is for

presentment may be made by S.W.I.F.T., tested telex, or other “similar authenticated means”

– Issuer may always permit l t i t t i itMore modern practice is for

beneficiary simply to certify that it is entitled to present the draft under the standby

electronic presentment in its discretion



ISP 98ISP 98• Examination • Extraneous documents

– Following a presentation, the issuer (or confirming bank) must examine the documents for conformity

are those not required by the standby– These don’t have to be

i ddocuments for conformity to the standby

– Examination is limited to ascertaining whether the presentation satisfies the

examined– They shall be

disregarded for purposes of determining whether presentation satisfies the

requirements set out in the standby

– Non-documentary diti i th t db

gthe presentation conforms to the standby

• Consistency is not part of the examinationcondition in the standby

are disregardedof the examination unless the standby provides otherwise



ISP 98

• No formalities required • Unless the standby q(notarization, officialization, witnesses) unless stipulated in the standby

yrequires the presentation of an electronic record, issuer owes applicant no duty to ascertain thestandby

• If formalities are required, issuer is not required to vet the authenticity of the

duty to ascertain the identity of the person making the presentation– But note that if the standby

i th t tiy

indicia of notarization etc.– Apparent compliance is

sufficient to authorize payment

requires the presentation of a bill of exchange, the issuer is bound by the law of negotiable instruments to make payment only to apayment to make payment only to a holder



ISP 98: Legal DocumentsISP 98: Legal Documents• Unlike the situation with • Issuer’s examination isUnlike the situation with

commercial credits, a standby is not transmuted into an

Issuer s examination is limited to the apparent good order of the documentstransmuted into an

accessory surety bond by requirements for court decrees arbitral

documents• Issuers should examine

their Financial Institution Bonds to seecourt decrees, arbitral

awards, government-issued documents and the like

Institution Bonds to see what insurance they have for defending against claims that thethe like against claims that the nonconformity of the presentation was patent



ISP 98: Examination Standard

• “A document presented • The UCP requires strict punder a standby is to be examined in the context of standby practice under these Rules even if the

qcompliance with the terms of the credit– Issuer of a commercial

credit makes payment asthese Rules even if the document is of a type (such as a commercial invoice, transport d t i

credit makes payment as the applicant’s agent

– Agent who does not strictly comply with his principal’s instructions isdocuments, insurance

documents or the like) for which the Uniform Customs and Practices for

principal s instructions is not entitled to reimbursement for expenditures made

Documentary Credits contains detailed rules”



Demand GuarantiesDemand Guaranties• The Uniform Rules for • Undertaking is given

Demand Guaranties, ICC Document 458, defines these as an undertaking to pay money upon a

g geither– at request of the Principal

and under its liability orAt the request of a bank orto pay money upon a

presentation of a written demand for payment in accordance with the terms f th d t ki

– At the request of a bank or insurance company (the “Instructing Party”) acting on behalf of the Instructing Party’s own client which isof the undertaking

• Other documents (architect’s certificate, judgment or arbitral

Party s own client, which is also a Principal

• The Guaranty is “independent” on the same terms as discussedjudgment or arbitral

award) specified in the Guaranty

same terms as discussed for letters of credit



Demand GuarantiesLike an L/C or standby, a guarantee should specify:

• The Principal • Expiry Date or• The Principal• The Beneficiary• The Guarantor

• Expiry Date or Expiry Event

• Terms forThe Guarantor• The underlying “value

transaction” that calls

Terms for demanding payment

• Any provisions forfor the Guaranty

• Maximum amount

Any provisions for reduction of the guarantee amount

payable and currency in which payable



Demand GuarantiesDemand Guaranties• Examination • CounterguarantiesExamination

standard: Guarantor shall exercise due care to ascertain

Counterguaranties– When an Instructing

Bank requests a confirming bank to i it t fwhether the

documents presented appear to conform to

issue its guaranty for the account of the principal, it generally issues a credit to thepp

the term of the guaranty

• Essentially the same

issues a credit to the confirming bank stipulating the amounts the Instructing Bank will reimburse to thesse t a y t e sa e

standard as applies under ISP98

will reimburse to the confirming bank, and on what terms and conditions



CounterguarantiesCounterguaranties• The counterguaranty is • In other markets, g y

implied when the instructing bank requests the confirming bank to establish a guaranty “for

,counterguaranties are used to allocate risks of non-completion and paymentestablish a guaranty for

our account”• If a formal credit is issued,

the Instructing Bank does

payment– Instead of retaining 10% of

progress payments, developers in the Middle East will release the entireg

so for the principal’s account in order to establish its right to reimbursement from the

East will release the entire contract sum in exchange for a counterguaranty from the contractor for 10% of the price of the workreimbursement from the

Principalthe price of the work



CounterguarantiesCounterguaranties• The contractor’s guaranty is

l t l• The objective then becomes

fi i t h f h d thalmost always a counterguaranty because the developer generally furnishes a bank guaranty covering payments to the contractors

figuring out how far ahead the contractor really is and providing for a bank guaranty to cover that difference

• Bank guaranties are often usedpayments to the contractors• Other layers of

(counter)guaranties come into play when mobilization payments mean that the owner

• Bank guaranties are often used as a functional substitute for performance bonds

– Fundamental difference: performance bonds are written for payments mean that the owner

has laid out more money than the work is actually worth

pthe full amount of the contract

– Bank guaranties or L/Cs for that amount would be prohibitively expensive

– Owner/Developer must be moreOwner/Developer must be more proactive because it can’t sit back and make the surety pay for the mess



Types of Bank GuarantiesypVery similar to surety bond products

• Tender Guaranties correspond t Bid B d i US l

• Maintenance and Warranty G tito Bid Bonds in US parlance

– Generally payable on First Demand

• Performance Guaranties pays an owner if a contractor has not

Guaranties– Functionally similar to the

Performance Guaranty but covers post-completion defects only

– Generally written for much lessan 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

Generally written for much less than a corresponding performance guaranty

• Repayment/Advance Payment Guaranties

I t d f b i d ith• Retention Guaranties– Instead of retaining 10% of each

progress payment, Owner pays 100% of the value of the work each payment and the contractor

– 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 whicheach payment and the contractor

furnishes a guaranty to substitute for retention

performance of Work for which the Owner has made advance mobilization payments



Types of Bank GuarantiesTypes of Bank Guaranties• Anything that can be • Bank guaranties are y g

done with a standby can be accomplished with a properly-drafted b k t

goften required as security for food exporters in Europe

bank guaranty, including provision of security for a lease, purchase & sale

– Exporters are charged an amount intended to recoup the government subsidies on the purchase & sale

agreement• Bank Guaranties are

accepted as security for

production of their foods– When exporting foods,

the exporters typically provide the customsaccepted as security for

the payment of import duties throughout the EC

provide the customs collectors with bank guaranties for the amounts being recouped



FraudTh h l id b hi d N th l th l• The whole idea behind these instruments is their absolute nature

• Nonetheless, the rule has grown up that fraud may be sufficient to

• If a seller of goods falsely certifies that he has shipped the goods

inspire a court to enjoin an issuer from making payment or to enjoinhas shipped the goods

covered by the buyer’s letter of credit, he most lik l

payment or to enjoin the beneficiary from presenting a draftTh i t d l tlikely can secure

payment under the L/C long before Buyer

• There is a great deal to be said about fraud….so much that

realizes that he has been had

we’re not going there today. Fraud needs its own program



own program

Letters of Credit, Stand by Letters and Bank Demand

Documents

Transcript of Letters of Credit, Stand by Letters and Bank Demand