Friday, 13 December 2013

Negotiating Documents under Unconfirmed Letters of Credit

Q.  Over the years it seems that Banks in the UK have to some extent lost their appetite to act on their nomination and truly "negotiate" documents presented under unconfirmed Letters of Credit. It used to be quite commonplace for a beneficiary of such an L/C to ask their bank to negotiate , and this request was regularly acceded to, albeit on a "with recourse" basis. This practice seems to be much less common now.

Is this perception true?

A.  In order to provide a balanced answer to this question it is important that Article 12 of UCP 600 regarding "Nomination" is examined. 

It is stated in a). "Unless a nominated bank is the confirming bank, an authorization to honour or negotiate does not impose any obligation on that nominated bank to honour or negotiate, except when expressly agreed to by that nominated bank and so communicated to the beneficiary".

Therefore a nominated bank is under no obligation to negotiate, i.e. to advance funds to the beneficiary on or before the banking day on which reimbursement is due to the nominated bank.  It is, and always has been, the nominated bank's decision as to whether to negotiate or not. However, it is also probably the case that many major UK banks are less inclined to agree to offer to negotiate unconfirmed Letters of Credit these days, and generally they will not proactively offer this when the Letter of Credit is initially advised through to the beneficiary. In most cases the advice to the beneficiary will state that the Letter of Credit is advised "without liability or engagement" (of the advising bank). 
The actual risks for the nominated bank to negotiate should be considered, and these are in line with the risks which would evaluated, had the Issuing Bank requested confirmation to be added. The main considerations would include;

  • The financial standing of the Issuing Bank.
  • The Political/Economic/Sovereign risks associated with the country of the Issuing Bank.
  • That there are no other reasons which would preclude a limit being marked on the Issuing Bank such as sanctions against the country etc.
  •  If drafts are called for, who are the drafts drawn on?
  • How is the negotiating bank able to claim reimbursement under the terms of the L/C? 

 In previous years, if a nominated bank was willing to consider negotiating the documents, and having satisfied themselves regarding the financial standing of the Issuing Bank and associated Country Risks, they would seek to levy a commitment fee from the beneficiary. This fee was generally broadly in line with the confirmation charge, had the Issuing Bank requested confirmation to have been added. On payment of the fee, the nominated bank would then examine the documents, and if they considered them to be compliant, would pay the beneficiary "with recourse". 

"With recourse" means that the beneficiary of the Letter of Credit is legally responsible for the repayment of the funds, and the payment will be shown as a liability on the beneficiary's balance sheet. 
However, in most cases, the beneficiary used not to request negotiation until they had presented documents. This left them exposed, from the period that the original Letter of Credit was received, to the point that the nominated bank agreed (or declined) to negotiate.

Clearly this practice is still available and many banks will give due consideration under a "Commitment to Negotiate" or "CTN" as it is commonly known. 

A CTN is a more formalised offering of the above mentioned practice of taking of a commitment fee, but Banks still do not proactively offer or publicise this service. It is only considered, usually for the bank's own customers, on a case by case basis. The principal risk to the negotiating bank in a CTN is Documentary Risk, as the CTN is only truly valid when the negotiating bank determines that the documentary presentation is compliant, although clearly the afore-mentioned Country & Issuing Bank risks are also key once the presentation is made. 

The bank's obligation under the CTN exists from the time of receipt of a compliant presentation until the due date for payment at which time the bank must pay without recourse - so in this respect a CTN is actually better for the beneficiary of the L/C than the former practice of paying a commitment fee, but getting paid the proceeds "with recourse".

In some circumstances, the Issuing Bank may be unwilling to ask for their Letter of Credit to be confirmed, perhaps because they consider this to be questioning their integrity, with a suggestion that they will not honour their own paper. So beneficiaries frequently require some added security to an unconfirmed Letter of Credit, with the added benefit of an acceleration of payment.

In summary, the broad perception relating to the original question is probably true, but times change and banks generally have become more risk averse in recent years, especially since the 2008 global financial crisis. Beneficiaries of Letters of Credits should approach their banks, and investigate their appetite to truly "act upon their nomination".