17 June 2008

Transferable Letter of Credit: Is It Really "Transferable?"

Letter of credit can be qualified in a number of ways and it is well recognized that a transferable credit is no different from any other apart from the fact that it enables the beneficiary of the credit to “transfer” the benefit to a third party. Where the credit itself is not stated to be transferable, no transfer of the credit is permitted because to do so would defeat the purpose of the credit.

The transferable credits are commonly used where the beneficiary contracts with a third party in order to obtain goods which are necessary to fulfill his obligations to the issuing bank’s customer. In such a case, the beneficiary will often be required to transfer the benefit of the credit to the third party in order to fulfill his obligations to that party.

Article 54 of UCP 400, Article 48 of UCP 500 and Article 38 of UCP 600, incorporated the relevant provisions relating to the transfer of a letter of credit. However, its interpretation has long troubled bankers, particularly with regard to the obligations placed upon the issuing or confirming banks.

A decision of the Privy Council considered this issue, and held that, although a beneficiary had the right to instruct the bank, which issued a transferable letter of credit, to make the credit available to one or more third parties, by Article 54(c) of UCP 400, no bank asked to transfer the credit was obliged to do so except to the extend and in the manner to which the bank expressly agreed. Furthermore, the designation of a letter of credit by the issuing bank as transferable was insufficient to constitute consent to a subsequent transfer request by the beneficiary.

The brief facts of the case were that Lariza (Singapore) Pte Ltd had agreed to sell crude palm oil to Bakrie Brothers (Singapore) Pte Ltd. It was a term of the contract that payment for the oil was to be made by means of a transferable irrevocable sight letter of credit to be opened in favour of Lariza, the opening of which was to be advised through the Bank of Canton Limited. In order to fulfill its agreement with Bakrie, Lariza entered into an agreement with Ban Lee oil Mill Co for the purchase of a corresponding quantity of crude palm oil which would be passed on to Bakrie. Payment of the Ban Lee contract was also to be made by an irrevocable sight letter of credit opened in their favour.

On 27 February 1980 (UCP 400 was in forced), a transferable irrevocable sight letter of credit was opened by Bank Negara Indonesia in favour of Lariza for the account of Bakrie and in due course Lariza requested Bank Negara Indonesia to transfer part of the letter of credit to Ban Lee, but the bank persistently refused to effect the transfer. As a result Lariza failed to perform its obligations under its agreement with Ban Lee and were sued by Ban Lee for damages for breach of contract.

Lariza subsequently brought an action against Bank Negara Indonesia claiming damages for breach of contract arising from the issuing and opening by the bank of the letter of credit. That claim was resisted by the bank, which contended that it was not under any obligation to effect the transfer of the letter of credit as requested by Lariza.

The case eventually reached the Privy Council , which held that under Article 54 of UCP 400, a bank which issued a transferable letter of credit could not, without more, be taken to have consented in advance to any request by the original beneficiary to transfer the credit to a third party. The consent contemplated by paragraph (c) of Article 54 was held to be a consent to effect the transfer to the particular extend in issue, and in that particular manner. Such a consent cannot be given in blanket form in advance, so as to apply to any request for transfer which may subsequently be made, whatever its extend or manner may be. Any consent given by the issuing bank must be an express consent which is made after the request by the beneficiary and it has to cover both the extent and the manner of the transfer requested.

It is submitted that if the view of the Privy Council is correct the whole purpose of the transferable letter of credit is effectively destroyed. A transferable credit should be transferable at the instance of the beneficiary and neither the issuing nor confirming bank should be able to refuse to transfer the credit, for otherwise the commercial purpose of such instruments would be defeated. Such restriction clause which appeared in UCP 400 and UCP 500 is still maintained in UCP 600 today.

04 June 2008

Bank Guarantee: Part 2

Bid Bond (Tender Bond)
This guarantee is required in connection with public tenders. If a company participates in such a tender, it must submit a bid bond together with its offer. Bid Bonds therefore secure payment of the guarantee amount:

1. in the event of withdrawal of the offer before its expiry date
2. if the contract, after being awarded, is not accepted by the tenderer
3. if the bid bond, after the contract has been awarded, is not replaced by a performance bond

As a general rule, the guarantee amount is normally within 1% to 5% of the amount of offer. The validity period of the guarantee is until the signing of the contract or the issue of a performance bond, usually between three and six months.

Performance Bond
The bank undertakes, at the request of the seller, to pay the beneficiary the guaranteed amount in the event the supplier has not met or insufficiently fulfilled his contractual delivery obligations. The guarantee amount usually 10% of the contract amount. The bond remains valid for the full amount until complete performance of the contract. Where contracts for works and materials are concerned, this generally includes the warranty period for the correct functioning of a machine or system. The period of validity of performance bonds may be two years or longer.

Advance Payment Guarantee (Letter of Indemnity)
The terms of payment for major export orders generally stipulate that the buyer pays an installment for the purchase of raw materials and for the cost of production. However, such a down payment will only be agreed to by him after receipt of so called advance payment guarantee which ensures repayment of the advance by the seller in the event of non-performance of his contractual obligations. The amount guaranteed is 100% of the advance payment. In contrast to the performance bond, the advance payment guarantee should stipulate that the guaranteed amount be automatically reduced in proportion to the value of any partshipments made. A utilization of the related documentary credit is usually recognized as avidence of delivery. The validity of the advance payment guarantee should be limited in such a way that it expires on the date the covered performance is made.

The advance payment guarantee must usually be issued before prepayment is made, but should enter into force only after receipt of such payment. Therefore a clause to this effect should be included in the guarantee whenever possible.

01 June 2008

Bank Guarantee

In international trade, it is difficult for the buyer to accurately assess the professional ability and financial position of a supplier or seller. The situation is worst when both parties are domiciled in different countries. The buyer therefore, quite rightly, demands that the seller’s ability to perform be secured and for this purpose a Bank Guarantee (BG) is arranged. In general, the use of the BG as an instrument for securing payment is restricted in international trade to non-payment guarantees used for the “open account” mode of payment.

A BG may be defined as the "irrevocable obligation of a bank to pay a sum of money in the event of non-performance of a contract by a third party". Similar to Letter of Credit, the guarantee is a separate obligation independent of the principal debt or the contractual relationship between the creditor and the principal debtor. Under the terms of the guarantee, the bank has to pay on first demand provided that the conditions contained in the guarantee are fulfilled. Guarantees are, as a rule, subject to the laws of the country of the issuing bank. Meaning to say, when a BG is issued by a bank in Malaysia, it is governed by the Malaysian laws. Under Swiss law, the parties are free to determine the contents and form of a guarantee. Generally, the contents of a BG more or less is standardized to suit to the issuing bank’s laws. However, minor adjustment is permissible subject to approval of the issuing bank. Issues or clauses not provided for would be adjudicated on basis of Article 111 of the Swiss Code of Obligations.

There are few example of related guarantees for securing performance or payment namely, the ‘simple’ guarantee (Swiss Code of Obligations, Art 495) and the ‘Joint and several’ guarantee (Swiss Code of Obligations, Art 496); by the contract of guarantee, the guarantor is obligated to make payment if the principal debtor becomes insolvent and goes bankrupt. The contract of guarantee presupposes a valid principal debt and also become void if the principal debt ceases to exist. In Switzerland, contracts of simple and/or joint and several guarantees are used almost exclusively for securing claims of domestic creditors.

The confirm payment order (Swiss Code of Obligations, Art 468); As in case of the guarantees, the irrevocable confirmed payment order includes an irrevocable, not accessory obligation to pay. Payments under this instrument can be subject to the fulfillment of the special conditions of this order. The documentary credit is an important case of application of the irrevocable, confirmed payment order.

As in the case of the documentary credit and the documentary collection, the International Chamber of Commerce in Paris has issued ‘Uniform Rules for Contract Guarantees’. But these guidelines issued in 1978 have not been generally accepted.
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