Does UCP 600 allow Discounting or Prepayment under Deferred

Payment & Acceptance LCs?

Ahmir Mansoor
Head of Trade Services
MCB Bank Ltd.
Karachi.
Amongst the many important changes in the UCP 600, one critically
important change was the authorization given to a nominated bank to
prepay/purchase/discount credits under an acceptance or deferred payment
letter of credit (LC). Previously, UCP 500 articles 9 stated that the
responsibility of banks under an acceptance or deferred payment credit was
to pay at maturity. Before we explain the position under UCP 600, let us
discuss two famous court cases wherein prepayment/purchase under an
acceptance or deferred payment credit was contested, and became the main
reason for introducing new sub article 12(b) in the UCP 600.
Credit Lyonnais v. Canara Bank International Division: - This case
brought the Supreme Court of France to render its first judgment on
discounting documentary credit available by acceptance. The court
reaffirmed the internationally upheld rule that no payment is due to a
confirming credit when fraud is established before that performs its
undertaking under that credit. The crucial question is therefore when is a
confirming bank considered to have performed its undertaking under that
credit available by acceptance?
The court decided that a confirming bank only performs its undertaking
under a documentary credit available by acceptance when that bank actually
pays the draft it had previously accepted.
As Credit Lyonnais had only accepted the draft but not made payment there
under at the time when fraud was established, it could not be considered as
having performed its undertaking under the credit. This being so, the court
denied its entitlements to reimbursement.
This ruling is the exact application of UCP 500 Sub article 9(b)(iii)(a)if the
Credit provides for acceptance by the Confirming Bank to accept Draft(s)
drawn by the Beneficiary on the Confirming Bank and pay at maturity. The
confirming banks undertaking is therefore twofold: it has to accept and to
pay at maturity to become entitled to reimbursement.

Banco Santander SA v. Banque Paribas: In this case Santander (London)

advised and confirmed a letter of credit issued by Paribas (Paris). This credit
was available with Santander by deferred payment 180 days from bill of
lading date. The confirming bank (Santander) received facially complying
documents, took them up, and thereby incurred a deferred payment
obligation.
Few days later, the confirming bank (Santander) paid to the beneficiary the
discounted value of its deferred payment obligation. A week later the
applicant notified Banque Paribas (the LC issuing bank) who then notified the
confirming bank (Santander), that the documents were false. The issuing
bank (Paribas) refused to reimburse the confirming bank because that fraud
was made know to the confirming bank before payment was due under the
letter of credit. Both the banks requested the court to rule on the legal effect
of beneficiary on the confirmers right to reimbursement. According to the
court the letter of credit was subject to the UCP 500 and the relevant Sub
article is 9(b)(ii) if the Credit provides for deferred payment to pay on the
maturity date(s) determinable in accordance with the stipulations of the
Credit. The question raised by the judge is what precisely the Issuing Bank
has requested the Confirming Bank to do and what the Issuing Bank has
promised to do if the Confirming Bank does what is requested of it. The
answer is that the Issuing Bank has requested the Confirming Bank to give
its own undertaking to pay on maturity. In addition to that the issuing bank
has promised to reimburse the confirming bank when it pays on that
deferred payment undertaking.
The court noted that if a confirming bank wishes to be free to give value for
documents when it accepts the documents. It can do so by insisting on
obtaining authority to negotiate and confirmation from Banque Paribas that
Banque Paribas would still reimburse on the due date, Banque Paribas would
not be able to raise the fraud exception because they would be estopped
from disputing Santanders authority to discount, as that authorization would
have been given expressly in response to the request from Santander.
The payment instructions i.e. payment on the maturity date remained
unchanged from the UCP 500 articles 9(b) (ii) & (iii) in the acceptance or
deferred payment credit. Under the UCP 600 sub-articles 2 honour includes:
b. to incur a deferred payment undertaking and pay at maturity if the credit
is available by deferred payment.

c. to accept a bill of exchanges (draft) drawn by the beneficiary and pay at

maturity if the credit is available by acceptance.
The insertion of UCP 600 Sub-Articles 12(b) is intended to give
reimbursement security to the nominated bank By nominating a bank to
accept a draft or incur a deferred payment undertaking, an issuing bank
authorizes that nominated bank to prepay or purchase a draft accepted or a
deferred payment undertaking incurred by that nominated bank. This came
about directly as a result to the outcome of the above court case although
various counties banks were looking for a specific provision to be inserted in
UCP 600 to allow discounting and protecting payments under the deferred
payment/acceptance LCs of their corporate customers. Such discounting
plays an enormous role in providing liquidity to the trading sector-a crucial
component of the customer base of most banks.
UCP 600 has been in force since 1 July 2007 but even after two years the
contents of sub-articles 12(b) have, unfortunately, been interpreted
differently by trade practitioners in the context of the situations wherein the
nominated bank incur their deferred payment or acceptance undertaking.
The crux of the problem lies in the understanding of the word when is the
promised protection offered to the nominated bank. What follows below is
the authors advice on how to deal with this critical question.
Before deciding to prepay/purchase/discount under an acceptance or
deferred payment credit the nominated bank should follow MT 700 field 41a
Available with - & field 42a Drawee_____ . it must be remembered that a
credit can be made available with an issuing bank by honour i.e. payment,
deferred payment or acceptance & with the nominated bank by honour and
negotiation. UCP Article 2 defines Nominated bank the bank with which the
credit is available or any bank in the case of a credit available with any
bank. The beneficiary may request any bank to honour or negotiate.
In addition to authorization in sub-articles 12(b) sub-article 7 or 8 (c) talks
about reimbursements in the case of prepayment or purchase before the
maturity. UCP 600 Sub-Article 8(c) states that a confirming bank undertakes
to reimburse another nominated bank that has honoured or negotiated a
complying presentation and forwarded the documents to the confirming
bank.

Reimbursement for the amount of a complying presentation under a credit

available by acceptance or deferred payment is due at maturity, whether or
not another nominated bank prepaid or purchased before maturity.
When and on which condition nominated bank is protected under
sub-articles 12(b) is a key consideration:
A credit is available with the nominated bank by deferred payment provides
the nominated bank with an authorization to prepay or purchase a deferred
payment undertaking incurred by the nominated bank.
Sub-articles 12(b) covers two aspects: a) that the nominated bank must have
incurred a deferred payment undertaking i.e. to give an undertaking to the
beneficiary to pay on a certain date in the future. by that unless the credit
excludes or modifies the rule, the nominated bank has the authorization of
the issuing bank to prepay or purchase. Any such advance will be within LC
and the UCP rules. Let us look at some practical examples so that we can
understand how this can be applied in practice.
1. A credit is available with the issuing bank by deferred payment (draft not
applicable) in this case if a presenting bank/non-nominated bank prepays
or purchases the documents after receiving maturity confirmation from the
issuing bank. They are not doing so under the authorization granted and
there is no protection under sub-article 12(b) & sub-articles 7(c) will not
apply. Bank would need to seek the agreement of the issuing bank to
discount, and can only proceed after receiving same. Otherwise the bank will
carry the risk of non-reimbursement in the event of fraud or court
injunction..
2. A credit is available with the nominated bank by deferred payment.
Documents under the credit were forwarded to the issuing bank without
providing an undertaking to the beneficiary. If the bank wishes to discount
the documents after acceptance by the issuing bank, then the nominated
bank should request the agreement of the issuing bank to incur their
deferred payment undertaking and then to prepay thereunder or the
nominated bank, when forwarding the documents to the issuing bank, should
have requested the authorization of the issuing bank to incur their deferred
payment undertaking as the nominated bank has not acted on their
nomination as the nominated bank has not acted on their nomination at the
time documents were presented. The nominated bank subsequently acted on

their nomination by incurring their deferred payment undertaking and made

a prepayment to the beneficiary prior to the maturity date. Otherwise
discounting by a nominated bank, of the issuing banks deferred payment
undertaking is not covered by sub-articles 12(b).
If the issuing bank is faced with a court injunction before the issuance of
their undertaking, the nominated bank may be in a difficult position of
determining that the undertaking was gives in good faith.
3. A credit is available with the nominated bank by deferred payment.
Nominated bank has incurred deferred payment undertaking but no
prepayment has occurred. At this point the nominated bank has no interest
in the funds as they have not paid the beneficiary. The court injunction will
stop the process and the beneficiary will not be paid. In Banco Santander v
Banque Paribas case if Santander has not discounted there would be no
potential for loss and the injunction would not have harmed the innocent
parties i.e. the banks.
4. A credit is available with the issuing bank by acceptance and draft drawn
on the issuing bank does not authorize another bank to prepay or discount
the draft. Any such 7c and no protection is available. On the other hand if the
credit is available with the nominated bank by acceptance with draft to be
drawn on the nominated bank the bank at the time of document
presentation will decide whether or not they would accept the draft
(assuming this is not a confirmed credit). Having chosen to accept the draft,
the nominated bank has created an undertaking to honour on the due date.
Any discount of the draft will be covered under sub-articles 12b and 7(c).
If the nominated bank follows the requirement of 12b i.e. to incur deferred
payment or accept draft at the time of their determination of compliance and
if a prepayment has occurred the nominated bank should be protected by
the UCP 600 and can book their exposure under Bank Risk.
Conclusion
Since June 2007, there has been only one case reported to the ICC Banking
Commission Paris on the pre-payment under a deferred payment credit and
non-reimbursement at maturity by the issuing bank date due to court order
which is violation to sub-articles 12(b) and 8(c). The last ICC Trade Finance
Report (11 November 2008) noted an increase in the number of court
injunctions barring payment under letters of credit on grounds other than

fraud i.e. goods quality issues, applicant requesting issuing banks for intense
scrutiny of documents, eventually leading to higher rates of rejection of
trade documents under L/Cs for minor discrepancies. Such events are most
likely driven by the increased risk in international banking markets due to the
financial and liquidity crisis.
The basis for injunction is usually related to applicants quality claims and
therefore a nominated bank that acted in good faith should be protected by
contesting UCP 600 articles 4 and 5. Article 4 reads A credit by its nature is
a separate transaction from the sale or other contract on which it may be
based. Banks are in no way concerned with or bound by such contract, even
if any reference whatsoever to it is included in the credit. Article 5 reads
Banks deal with documents and not with goods, services or performance to
which the documents may relate. Due to the content of sub-article 12(b) and
8(c) the issuing bank will seek to have the injunction removed , which will
preserve the autonomy of its credit and UCP. The issuing bank would also be
well advised to inform their applicants of the content and effect of sub article
12(b) under deferred payment or acceptance credit. If the only purpose for
deferred payment credit is to avoid the requirement of draft and to restrict
the payment till the maturity date then it is advisable to exclude sub-article
12(b) & 8(c) in the credit.