Volume 42 | Number 3 Summer 2007
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II. Negotiation in Letter of Credit Practice
A letter of credit is not a negotiable instrument.7 There are, however, negotiation credits—credits under which negotiation is permitted.
Although letter of credit practice was originally linked with negotiable instrument practice, the ties between the two fields of commercial law have become increasingly attenuated. Under standard international letter of credit practice, with the exception of acceptances, negotiable drafts or bills of exchange are an anachronism. The declining status of the draft can best be viewed from the perspective of the doctrinal evolution of the letter of credit concept of negotiation in the rules of practice that are applicable to most commercial letters of credit, the Uniform Customs and Practice for Documentary Credits (hereinafter UCP).8
A. Pre-UCP400 Terminology
Negotiation is a concept that has been with modern letters of credit from the early twentieth century, the first point in time where LC doctrine can be reliably tracked.9 LC undertakings at that time invariably involved a draft that was typically accompanied by documents.10 While the parties to the underlying transaction were interested in the documents, the focus of the banker’s attention was on the draft that accompanied them.11 For a banker, the draft contained his or her instructions. The banker read the draft as a merchant would read the commercial invoice—as the compass for the transaction. The draft informed the banker who was to be paid, the terms of payment expected, the amount, the currency, and who was expected to make the payment.
At the advent of the modern era, letters of credit required that a draft be drawn on the issuing bank. An LC contained one of two clauses. Straight credits, in which the draft was drawn on the issuing bank and could only be presented to the issuing bank, contained a clause of the following type: “We engage with the beneficiary that all drafts drawn under and in compliance with the terms of the credit will be duly honored on delivery of documents as specified if presented at your office on or before . . . 19 . . . .”12 Where presentation could be made to another bank, the credit would contain a clause of this type: “We engage with the drawers, endorsers, and bona fide holders of drafts drawn under and in compliance with the terms of the credit that the same shall be duly honored on due presentation and delivery of documents as specified . . . if negotiated or presented at . . . on or before . . . 19 . . . .”13 In effect, this latter engagement was understood to render the credit negotiable by this other bank. Where the bank was instructed to add its confirmation, that bank effectively engaged to negotiate drafts drawn on the issuer.14
Where the draft was payable at sight, negotiation consisted of paying the amount due under the letter of credit to the beneficiary after having examined the documents and concluding that they complied with its terms and conditions.15 Where the draft was a time draft, negotiation consisted of paying the amount due under the letter of credit to the beneficiary discounted to present value after having examined the documents. Where the bank had issued the credit or added its confirmation, it negotiated without recourse.16
B. Post-UCP400 Terminology
The term “nominated” was first introduced in UCP290 (1974) and the concept of nomination seriously developed in UCP400 (1983).17 A nomination entitles the person nominated to act under the credit and embodies an undertaking by the issuer and any confirmer to reimburse the nominated bank. The nomination empowers the nominated bank to act within the scope of the nomination and to undertake any act not inconsistent with it.
Nomination can effect to whom presentation may be made, the status of the bank with respect to amendments, the status of the bank with respect to revocable credits, the status of the bank in the event of claims of fraud on the part of the beneficiary or forged or fraudulent documents, or the ability of the bank to effect the transfer of drawing rights, and the entitlement to reimbursement. Nomination of a bank under an irrevocable credit gives an irrevocable right to a beneficiary to present documents to that bank for purposes of satisfying the condition that documents be timely presented prior to the expiration of the letter of credit whether or not it takes up its nomination. A nominated bank is not obligated to act by virtue of being nominated and may elect not to do so. With the exception of a confirming bank, a nominated bank does not make any engagement by advising the credit or by receiving a presentation, examining the credit, or forwarding it to the confirmer or issuer unless it expressly so indicates.18
Instead of distinguishing only between straight and circular (undertakings that were meant to circulate) as did earlier UCP versions, by UCP400 (1983) it was recognized that a bank could be nominated to confirm (confirming bank), pay (paying bank),19 or negotiate (negotiating bank).
These categories tended to overlap. Negotiation did not necessarily entail nomination and could be undertaken by the issuing bank which had engaged itself under its letter of credit. Nor was it confined to a negotiating bank since a confirming bank could make an undertaking to negotiate as well. Although not always fully grasped even by LC bankers, negotiation in post UCP400 LC practice encompasses two quite different functions. On the one hand, it represents a type of undertaking given by either an issuing or confirming bank to negotiate drafts drawn on either the applicant20 or issuer respectively and the fulfillment or honor of that undertaking.21 On the other hand, negotiation also consists of a nomination by the issuing bank of a bank that is authorized to negotiate drafts drawn under the credit but is not requested or authorized to add its own undertaking to the beneficiary. Such a nominated bank is characterized as a “negotiating bank” in LC practice. Although some writers and a few courts have confused the notion of nomination and negotiation with the doctrine of agency, agency is inapt to describe either.22 While this designation is somewhat illogical since both issuers and confirmers can also negotiate when they so undertake and could have been described as negotiating banks, it serves to reinforce the distinction between a bank that is obligated on the LC and one that is not. Where a negotiating bank is involved, the drafts can be drawn on a paying bank, the confirming bank, the issuer, the applicant, or a third person but not the negotiating bank.23
Following the format of SWIFT MT700 messages, UCP600 distinguishes between the notions of “Available With . . .” and “Available By . . . .”24 A credit is “available with” the issuer, or a nominated bank which can include a negotiating bank. It can be “available by” payment, deferred payment, acceptance, or negotiation. Where the credit is “available by” negotiation, the bank it is “available with” the negotiating bank.