Bank Collections, Trade Finance and Letters of Credit

Bills of Exchange or Draft: Negotiable Instrument • 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

Terminology • Seller =drawer & payee • Buyer or buyer’s bank= drawee

Bill of Exchange or Draft • Act as a substitute for money • Act as a financing or credit device

Negotiation of Order Instrument • Indorsement • Delivery

Drafts • 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

Holder 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

Letter 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 • Bank’s promise to pay is better than buyer’s

Factoring Accounts Receivable • Seller assigns rights to collect to assignee or factor • Does Assignee have the same rights as a holder in due course?

Letter of Credit: Law • Art. 5 UCC • Uniform Customs & Practice (UCP) incorporated into L/C • NY law states UCP not UCC is applicable

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

Basic Principles of L/C illustrated thru cases: L/C Is separate from the contract;Bank is obligated to pay if L/C is in order

Maurice O’Meara v. National ParkBank • 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.

Maurice O’Meara v. National Park Bank • 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.

Maurice O’Meara v. National Park Bank • 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.

Court may enjoin L/C when there is fraud in the transaction • Sztejn v. Henry Schroder Banking • 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.

Court may enjoin L/C when there is fraud in the transaction • 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 L/C, the court may enjoin payment.

BUT.. • Confirming banks are not permitted to refuse a demand for payment when the documents comply with the L/C • United City Merchantsv. 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.

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

Strict Compliance • 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.

Strict Compliance • 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.”

Procedures for Dishonor of L/C • 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

Confirmed Letters of Credit • Why needed?

Standby Letters of Credit • Why? Performance guaranty • American Bell v. 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

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

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

Countertrade • What? Exchange of goods Why? • Counterpurchase, barter, buyback • Russian economy example

Protection in sales • Contract-trade terms, clauses • Insurance • Letter of credit

Review 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

Bank Collections, Trade Finance and Letters of Credit