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930 - Case laws - Miscellaneoous
Fung King-tak on the legality of silent confirmation Credits Insight.Volume 7 No 1. Winter 2001 |
| Fung King-tak is a solicitor at Brown &Wood's Hong Kong Office specializing in banking and structured trade finance products. He was formerly the Vice President and Head of Trade Finance at Bank of America and has conducted a series of trade finance workshops for ICC Asia in both Hong Kong and the PRC. Many corporations adopt a policy that all export letters of credit ("L/Cs") received must be confirmed by their banker(s) in order to cover the payment and country risks of the L/C issuing banks. However, some L/C issuing banks do not prefer their L/Cs to be confirmed because they regard such an action as potentially having a negative impact on their credit standing. Accordingly, in order to meet market demand, it is not uncommon for banks to provide a service called "silent confirmation". Some banks call it "payment guarantee" or "commitment to purchase", which essentially mean similar "without recourse" financing arrangements between the silent confirmer and the beneficiary. What is silent confirmation? The exporter's bank incurs a definite payment undertaking in addition to that of the L/C issuing bank without the instructions/authorizations of the issuing bank. Accordingly, it undertakes to the exporter that it will honour the exporter's drawing(s), either by way of "making immediate payment" or "undertaking an obligation to make payment" on a "without recourse" basis provided that compliant documents are presented. Valid in law? UCP 500 does not cover silent confirmation. It is a purely separate contractual arrangement between the silent confirmer and the L/C beneficiary and is outside the L/C contract. Arguably, it can be a valid contract under English and Hong Kong law, provided the law of general contract principles such as consideration, offer and acceptance, certainty of terms, etc. are duly complied with. Nevertheless, the silent confirmer might not acquire the rights and protection of a confirming bank which is expressly authorized by the issuing bank under sub-Article 10(d) of UCP 500, i.e. the right to claim reimbursement from the issuing bank after effecting payment to the beneficiary. One ICC expert also holds a similar view: "... the advising bank adds such confirmation at its own risk, and thereby commits itself to the beneficiary, even if it cannot recover from the issuing bank 1 ." Risks The major exposure of the silent confirmer is that it negotiates the export documents on a "without recourse" basis but it might have no locus standi (i.e. not be in a position) to sue the issuing bank in its own name if the issuing bank defaults. This is because it is not a party to the L/C contract, as it has never been authorized by the issuing bank to add confirmation to the L/C. Accordingly, it might face a difficult situation where it can neither claim on the beneficiary (because the financing is on a "without recourse" basis) nor the issuing bank (because it is not a party to the L/C contract), even if the issuing bank withholds payment unjustifiably. This issue has deterred a number of banks from entering into this business. Mitigating the risk? It is not uncommon for a bank to perform different roles in an L/C transaction, e.g. the advising bank may also be a nominated bank (defined in sub-Article 10(b)(i) of UCP 500) which is authorized to pay, to incur a deferred payment undertaking, to accept draft(s) or to negotiate. By acting as a nominated bank, it is entitled to be reimbursed by the issuing bank under sub-Articles 10(d) and 14(a). Accordingly, the silent confirmer may claim its money back from the issuing bank in the capacity of a nominated bank without disclosing its silent confirmer status. This is probably workable because the silent confirmation arrangement, as discussed above, is separate and independent from the L/C contract. In addition, the payment obligation of the issuing bank depends on the compliance of documents presented, not the status of the presenter. However, as demonstrated in a recent court case, Banco Santander v. Banque Paribas, it appears that providing financing against a deferred payment credit is not expressly authorized in the credit, so the financing bank is acting at its own risk. The silent confirmer may not be able to claim reimbursement from the issuing bank under UCP 500 if fraud is established subsequent to the discounting but prior to the maturity date of payment under a deferred payment credit. One possible way to overcome this constraint is to obtain the issuing bank's authorization to discount prior to the maturity date 2 . Checklist 1. Is the silent confirmer a nominated bank? Some banks only accept L/Cs which are available by negotiation or acceptance and have named them as the nominated banks. The relevant bank may have to take an extra step to obtain the issuing bank's authorization in discounting the documents if the L/C is a deferred payment credit as explained above. It would be ideal if it were also the advising bank so that it may have control over all future amendments, if any. 2. Is a draft required? A draft is called for under an acceptance credit in order to create a banker's acceptance. A draft is normally called for under a negotiation credit, but arguably the provision of a draft is not absolutely necessary as sub-Articles 9(a)(iv) and 9(b)(iv) state: "if the credit provides for negotiation - to negotiate without recourse to drawers and/or bona fide holders, Draft(s) drawn by the Beneficiary and/or document(s) presented under the Credit." [Emphasis added] US codified law makes negotiable instrument law subservient to letter of credit policy and not vice versa. However, under English and Hong Kong law, the provision of a draft provides a separate cause of action against the issuing bank in addition to the rights provided in UCP 500. Moreover, if the silent confirmer negotiates the draft (which is complete and regular on the face of it) before it is overdue, in good faith and for value and without notice of previous dishonour or of any defect of the title of the transferor, it may obtain a title better than that of the transferor and may enforce payment against all parties liable on the bill 4 . One point to note is that a payee probably cannot be a holder in due course 5 . Accordingly, it is advisable for banks to reconsider whether the common practice of stating the name of the presenting bank as the payee in their drafts is in their best interests. It appears that a number of banks in Hong Kong have changed the payee of their drafts from the presenting bank to the drawer who then proceeds to endorse the drafts either in blank or in specialty (i.e. to a specified person or to the order of a specified person). Silent confirmation agreement To minimize the silent confirmer's exposure, it is advisable to have the beneficiary execute an agreement detailing the rights and obligations of both parties, in particular the exact types of risk that the silent confirmer has agreed to take or exclude. Conclusion Provided adequate control measures and documentation are in place, it appears that the risks borne by a silent confirmer are not substantially higher than that of a normal confirmation expressly authorized by the issuing bank. Success depends very much on a proper risk analysis and monitoring system as well as the documentary credit skills of the silent confirmer. With the increasing demands of this type of service, it appears that the rationale for not authorizing other banks to confirm one's L/C because of an issue of "face" is rather weak. First, if the beneficiary has concerns with respect to the issuing bank's credit standing, it will obtain a silent confirmation from its banker notwithstanding that the issuing bank has not expressly authorized such an action. More importantly, the beneficiary may mainly be concerned with the risks of the country where the issuing bank's branch or headquarters is located - such as imposition of foreign exchange controls, political instability, etc. as opposed to the credit standing of the issuing bank. It is not uncommon for banks to confirm L/Cs issued by their own branches if such issuing branches are situated in a high risk country. It may well be an appropriate time for banks to reconsider their policy of not authorizing other banks to confirm their L/Cs. I Fung King-tak's e-mail is [email protected] |