Chapter 7
Bank Collections, Trade Finance, and Letters of Credit
I. Bill of Exchange: AKA “international draft”
A. Origins
A sells to B, in exchange for paper promising to pay
A can use paper to buy from C, who can then use it to buy something else, or can cash it in with B. aka “acceptance”
In US, governed under UCC.
In
B. Brief Requirements
1. Unconditional order in writing
2. Addressed by one person to another
3. Signed by person giving it
4. Requirement that person to whom it is addressed pay on demand or at fixed time
5. A sum certain
6. To order of bearer, or specific person
C. Negotiation allows transfer to another person
D. DD and bank collection process
E. SWIFT system, allows international transactions to clear
II. Trade Finance
A. Use of time drafts and acceptances (see sample on 214)
B. Banker’s acceptances and acceptance financing (used to shift credit evaluation from buyer to bank)
C. Credit risk in trade finance programs
D. Holder in due course (generally takes free from disputes between drawer and drawee)
1. Takes for value
2. In good faith
3. Without notice that it is overdue or dishonored
4. Without notice that the instrument contains an unauthorized signature or has been altered
E. Rights of assignee (steps into shoes of assignor)
III. Documentary Letter of Credit
A. L/C defined (see sample on p. 226)
B. See chart on 219
C. Applicable law: UCC, Uniform Customs Practice for Documentary Credits (UCP) (only governs if incorporated by reference)
D. Principle
of
LC deal is separate from underlying contract. Normally, bank will pay on documents, regardless of what is happening in reality.
Maurice O’Meara Co. v. National Park Bank of NY, 146 NE 636 (CANY 1925)
Facts: Bank issued LC for import of newsprint. Turned out, newsprint was not of the required quality. However, all the documents were in order.
Issue: Does bank pay, or can it require inspection of newsprint?
Holding: Bank must pay.
Reasoning: LC deal is separate. Bank’s obligation to pay is triggered by the presentation of the required documents. Bank may not look at underlying deal. Buyer’s remedy is suit against seller.
E. Rights of Account Party (seller) in Case of Fraud
There is a narrow exception for fraud in the transaction. Appears to be limited to case where seller knows of the fraud and perpetrates the fraud.
Sztejn v. J. Henry Schroder Banking Corp., 31 NYS2d 631 (1941)
Facts: B bought hog bristles from S in
Issue: Must bank pay if there is fraud in the transaction, but documents are good on their face?
Holding: No. If document itself is fraudulent, bank may withhold payment.
Note: UCC says court “may” honor a draft even if it
has reason to know of fraud, but court may issue injunction.
.cf
Facts: S (English) sold glass fibers to B (
Issue: Must bank pay, if given notice of false BL?
Holding: No. Fraud in documents must be known to S. Severely limits principle of Szjetn.
F. Irrevocable LC (if does not say, it’s irrevocable)
G. Advising the letter of credit (S’s bank will advise S of B’s LC)
H. Seller’s compliance with LC
Make all documents comply with LC. See chart on 229 for common mistakes.
I. Collecting on the credit
If all docs in order, bank will pay.
J. Examination of docs under UCP
1. Rule of strict compliance
Some typos allowed, but very limited room for discrepancies.
Description of goods in commercial invoice must correspond with description in LC. Broader, but consistent, description is allowed in BL.
Courtaulds NA v. NC Nat’l Bank, 528 F2d 802 (4th Cir. 1975)
Facts: LC, documents transaction. LC called for “100% Acrylic Yarn”. Invoice described as “Imported Acrylic Yarns”. Packing list said, “Cartons Marked: 100% Acrylic”. Bank refused to pay due to discrepancy. B went bankrupt, and trustee refused to waive problem. S sued bank, and won in lower court, based on the packing list.
Issue: Was bank correct in refusing to pay?
Holding: Yes. Bank is not to scrutinize other docs, like packing list. Bank may not read into statements the intent of the parties.
2. Other views on strict compliance
5th Circuit goes for a more moderate approach, rejecting mirror image rule. More of a functional standard, some typos and minor deviations are allowed.
a. Avoiding and handling discrepancies
About ½ of LC transactions have discrepancies. Need to be very careful. If there are mistakes, S should not ship until docs are fixed. Fewer docs are better (less chance for mistake). S must meet all deadlines.
B. Ethical issues
Is it unethical to take advantage of discrepancy to avoid payment?
Should bank look for discrepancies if B wants out of deal?
Should B look for discount on price to waive discrepancy?
C. Procedure for dishonor
If docs are wrong, bank has tough call. Most banks have strict procedures for making these decisions. Must describe discrepancies to B, and ask for waiver.
D. Confirmed LC (bank guarantees the bank, usually not done)
E. 17 Steps (see p. 233)
IV. Other types of LCs
A. Standby LCs
1. Commonly used as performance guarantee
2.
American Bell Int’l Inc. v. Islamic
Facts:
AT&T/Bell had contract to do $280m worth of work
in
Issue: Can
Holding: No. Bank
probably will have to pay. If bank pays
wrongfully, then
Reasoning:
Bank needs to protect its reputation on LCs.
B. Other specialized uses of LCs
1. Transferable credits (used by traders who buy and sell docs without taking possession of goods)
2. Red clauses (smaller S gets promise by bank to pay loan from bank) very risky to B and B’s bank
3. Revolving and evergreen credits (allows B a large credit limit, which can be used over and over, and goes back up when B makes payments)
4. Back to back LC (S sells in one transaction, buys in another. The second transaction guarantees the first).
V. Electronic Data Interchange and eUCP
Will allow transactions to be done electronically instead of by paper
VI. LC in Trade Finance Programs
A. AID Financing
B. Eximbank Financing
C. Commodity Credit Corp.
D. Foreign Credit Insurance Association
VII. Countertrade
A. Counterpurchase
B. Barter
C. Buy-Back