1. 1 Bank Collections,Trade Finance and Letters of Credit Chapter 7 © 2002 West/ Thomson Learning

2. 2 Protection in Sales Contract-trade terms, clauses Insurance Bills of Exchange Letters of Credit

3. 3 Bills of Exchange or Draft: Negotiable Instrument Draft (or Bill of Exchange) “order to pay” issued by seller time draft or sight draft Requirements for draft: unconditional written order Addressed from one person to another Signed by person giving it Requiring that person addressed by it pay on demand or on future date Specified sum of money Pay to order of bearer or of specified person

4. 4 Terminology Seller = drawer and payee Buyer or buyer’s bank = drawee

5. 5 Negotiation of Order Instrument Negotiation: transfer of instrument from one party to another Supported by payment of value Holder takes legal rights Requirements for Negotiation: Endorsement (by signature) Delivery

6. 6 Acceptance of Drafts Drafts can be accepted by buyer, creating a trade acceptance Buyer agrees to pay unconditionally at the time stated on the draft Buyer accepts by marking “accepted” and signing Accepted draft returned to seller; can sell at discount or hold to maturity Banker’s acceptance: bank agrees to pay draft Banker’s acceptance is a negotiable instrument Can be used as flexible short-term financing instrument

7. 7 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

8. 8 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 Security: bank’s promise to pay is better than buyer’s

9. 9 Letter of Credit: Law Art. 5 UCC Uniform Customs & Practice (UCP) incorporated into L/C UCC – Art. 5 – defers to UCP: UCC not applicable to extent UCC is in conflict with UCP “eUCP” – rules for electronic transmission, adopted in 2002 NYS law: UCP, not UCC, is applicable to L/C’s

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

11. 11 Maurice O’Meara v. National Park Bank (NYC.A. 1925) Facts: NPB issued letter of credit to R (beneficiary) at request of SH to cover delivery of newsprint. R presented invoice and draft to NPB NPB refused payment because it could not test strength of paper During this time the price of newsprint dropped over $20,000 R transferred right to collect to O’Meara. Issue: Did NPB have the right to refuse to pay on the L/C despite presentation of the proper documents in order to ensure paper was the proper weight? Decision: No. The bank’s obligation is to pay when presented with the documents called for in the letter of credit. Contract btwn buyer and seller is separate from bank’s obligation on L/C Buyer still has a separate right of action against the seller for breach of contract.

12. 12 Sztejn v. J. Henry Schroder Banking (NY Sup. Ct. 1941) Facts: S contracts to buy hog bristles from T Bank opens L/C with seller as beneficiary T ships boxes of cow hair and rubbish T presents documents to bank for payment S brings suit to block bank from paying Issue: When there is active fraud, may court enjoin bank from paying on irrevocable L/C? Decision: Yes, where there is credible evidence of active fraud on seller’s part before bank has paid on L/C, court may enjoin payment. Contract between buyer and seller is separate from L/C Bank paying L/C before getting notice of fraud is protected if exercised reasonable diligence before paying

13. 13 Legal Issues of Bank Payment on L/C UK position: narrows Sztejn v. J. Henry Schroder rule United City Merchants v. Royal Bank : General Rule is that confirming banks are not permitted to refuse a demand for payment when the documents comply with the L/C Fraud by third party doesn’t constitute fraud in the transaction to allow bank to deny payment UCC s. 5-114: bank may honor draft despite notification from buyer of fraud, but court may enjoin payment NY: UCC doesn’t apply to L/C’s California: courts hold no injunction against payment

14. 14 Courtauld’s v. North Carolina Nat. Bank (4 th Cir. 1975) Facts: NCNB opened L/C for buyer (A) with seller (C), as beneficiary; L/C stated “100% acrylic yarn.” C presented invoice stating “imported acrylic yarn” and packing list “100% acrylic.” Bank refused to pay on L/C In the meantime the buyer went bankrupt C sued NCNB for payment; trial court held for C NCNB appealed. Issue: Was NCNB’s refusal to pay on L/C in violation of UCP and state law? Decision: No; reverse trial court decision Reasons: Description of goods on invoice did not match that on L/C NCNB entitled to insist on strict compliance Defect in invoice not cured by correct description in packing list NCNB need only treat documents marked “invoice” as invoice; no duty to examine collateral documents;

15. 15 Liability of confirming banks Why have a confirming bank? Concern about credit of issuing bank Currency restrictions Protect seller against issuing bank’s credit risk Confirming bank is liable on the L/C Entitled to reimbursement by issuing bank on presentation of documents Bears risk of issuing bank’s or buyer’s credit failure

16. 16 Standby Letters of Credit Used as performance guaranty Issued in favor of buyer Beneficiary need only present statement that default has occurred to collect For protection of seller, should require independent confirmation of default from third party

17. 17 Am. Bell v. Islamic Rep. Of Iran (S.D.N.Y. 1979) Facts: AB entered into contract with I for consulting and equipment Iran paid AB $38 million down payment Contract gave Iran right to demand return of down payment at any time for any reason AB arranged standby L/C with Man. Bank to benefit of Iranian bank Islamic revolution forces AB to suspend operations in Iran AB brings suit to enjoin Man. Bank from paying on L/C Issue: Will enjoin bank from paying on standby L/C? Decision: No. AB negotiated standby L/C terms with “eyes open” “One who reaps the rewards of commercial arrangements must also accept its burdens.” Man. Bank faces loss of credibility, and possibly more AB had other remedies available

18. 18 L/C’s & e-Commerce eUCP – adopted 2002 eUCP rules apply when both parties agree when electronically transmitting documents Rules address: Format of e-documents Authentification and digital signatures Transmission errors Manner of presentation SWIFT system: private, high-speed system among banks Bolero Project: replace paper-based system with electronic transmissions Identrus – founded to secure digital identities and signatures Will e-commerce system reduce errors?

19. 19 Countertrade Transactions involving exchange of goods rather than monetary payment 30% of world trade Exchange controls or currency restrictions Counterpurchase Barter Buyback Pepsi Cola and Stolichnaya example Risks involved?

20. 20 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