Letter of Credit Forum

Explanation to the UCP 500

A) General Provisions and Definitions (Article 1 to Article 5)

Introduction: General provisions and definitions precede the substantive part of the UCP. They concern the application of the UCP (Article 1); the definition of documentary promises to pay (Article 2), the independence of underlying transaction from the Credit (Article 3, 4), and the reminder to instruct banks completely and precisely (Article 5).

 

ARTICLE 1 Application of UCP

The Uniform Customs and Practice for Documentary Credits, 1993 Revision, ICC Publication No. 50O, shall apply to all Documentary Credits (including to the extent to which they may be applicable, Standby Letter(s) of Credit) where they are incorporated into the text of the Credit. They are binding on all parties thereto, unless otherwise expressly stipulated in the Credit.

 

 

 

Article 1, sentence 1 UCP 500, Incorporation by reference of UCP in Letters of Credit:

The majority view does not recognize the UCP as commercial usage or lex mercatoria; hence the UCP have to be incorporated by reference, under observance of national laws as e.g. the German law on trade terms (compare preface). For decades jurisdiction and academic literature have disputed whether the UCP are a kind of international consuetudinary law.

However this dispute is truly academic since banks incorporate the UCP as a matter of habit. The disputed qualification of the UCP is only relevant in cases, where national courts attempt to scrutinize waivers and limitations of liability. In these instances it needs to be decided whether the UCP are trade terms, subject to national laws, or whether they are consuetudinary law, exempt from scrutiny by national courts (compare explanation Article 15 UCP 500).

 

The incorporation by reference is important however, since it notifies the beneficiary that the issuing bank or its national banking organization have accepted the UCP in its most current version.

 

Article 1, sentence 1 UCP 500 Incorporation by reference in Standby Letters of Credit: The 1983 revision of the UCP included, for the first time, standby letters of credit in its scope of application. Standby letters of credit are basically guarantees issued by American banks, which -due to US banking laws-have to be issued in guarantee format; i.e. they are payable against presentation of documents. Until 1996 US-banks were prohibited from issuing guarantees or suretyships, whereas the issuance of L/Cs was allowed (footnote2). Since 1996 the office of the comptroller of the currency repealed this prohibition. However, it can be assumed that American banks will only avail themselves in exceptional cases of the possibility to issue guarantees payable on first demand. Rather American banks will continue to issue Standby Letters of Credit which are recognized by market participants and well established.

It should be noted, that on January 1, 1999 the ICC has published the Rules for international Standby Practices (ISP 98, ICC-Publication 590). For this reason, an applicant should clearly state, whether he wants the bank to issue the Standby according to the UCP 500 or the ISP 98.

 

Unclear scope of application for Standby Letters of Credit: The special position of the Standby is the consequence of the fact that the UCP 500 apply to Standbys "to the extent to which they may be applicable" (Article 1 UCP 500). This restriction takes into account that individual provisions of the UCP 500 do not fit Standbys; as e.g. the necessity of an expiry date in connection with the issuance of transport documents. The Banking Commission hence has refused to subject a Standby to the provision that transport documents need to be presented within 21 days of their issuance (Article 43 a UCP, formerly Article 47 a):

"The commission has decided that under a standby credit Article 47 a UCP does not apply, particularly where it is only a copy document which is, therefore, not a transport document."(footnote4)

 

The ICC however has not been able to generally designate the articles of the UCP not applicable to Standbys:

"NCs must acknowledge that not all the Articles in the UCP apply to a Commercial Credit or to a Standby Credit and that the majority of the Articles do not apply to the Standby Credit. It is recognized that the parties to the Credit may wish to exclude certain Articles of the UCP from a specific type of Credit."(footnote5)

 

Exclusion of or reference of individual provisions of the UCP in Standbys: Affaki advocates that the following rules are incompatible with Standbys and therefore should be expressly excluded:

all articles regarding transportation,

Article 17 force majeure,

Article 19 (Bank-to-Bank Reimbursement Arrangements),

Article 21 (Unspecified Issuers or Contents of Documents),

Article 41 (Instalment Shipments/Drawings) (footnote6).

 

Since the exclusion of individual articles as seconded by Affaki can be incomplete and contradictory, the authors recommend, to list those articles of the UCP 500 which are applicable in any case. Banks are mostly interested in clarifying, that the documents presented under a Standby will be examined as to their formal compliance with the Standby provisions and not as to their legal validity or correctness of content. Hence, it is recommended to stipulate that Articles 13 to 18 shall be applicable. A Standby need not but will normally have an expiry date, hence a reference to Articles 42 to 54 and also Articles 3, 4, 6, 10 a, 10 b, 14 and 20 UCP 500 seems advisable.

 

Standby Letters of Credit/ Uniform Rules for Demand Guarantees (ICC Publication 458): Correct in its conclusion, however fuzzy in its reasoning, the ICC has refused to include the Rules for Standbys into the Rules for Demand Guarantees:

" It was agreed unanimously that the Standby Credit is not to be merged with the Bank guarantee rules regulated by the ICC's Uniform Rules for Demand Guarantees (URDG), ICC Publication N. 458. While the Standby Credit is from a legal viewpoint, equal to the demand guarantee, there are important differences between the two. The Standby Credit has developed into an all-purpose financial support instrument embracing a much wider range of uses than the normal demand guarantee. For this reason, and since the UCP is the most suitable and compatible set of rules with the basic character of the Standby Credit, the link between the Standby Credit and the UCP was maintained."(footnote7)

 

Actually, no substantive difference exists between a Demand Guarantee and a Standby. The reason that the URDG are not accepted in the marketplace is the result of a stipulation -commonly considered legally void since surprising (footnote8)- which requires that the beneficiary in order to call the guarantee has to present documents or issue statements not mentioned in the guarantee itself.

 

Article 1, sentence 2 UCP 500 - Deviating from the UCP by excluding individual rules:

When the UCP are incorporated by reference in an L/C they apply in their entirety, "unless otherwise expressly stipulated in the Credit"(Article 1, sentence 2 UCP 500). For Standbys that are subject to the ISP 98 the American Bar Association recommends to modify 38 Articles. However, for the UCP modifications and clarifications are suitable only in exceptional cases, as e.g.

-Article 9 b UCP 500: presentation of documents to the confirming bank, even if the L/C is not payable with the confirming bank.

 

-Article 27 c UCP 500: in order to prevent transshipments in air transport, applicant should excluded Article 27 c UCP 500

 

-Article 40b UCP 500: modification of the rules for partial shipment through stipulation of deadlines.

 

 

If the applicant intends to deviate from the UCP, the text of the Credit should visually emphasize the deviation -e.g. using bold font, in order to avoid surprises with the beneficiary.

 

Article 2 Meaning of Credit

ARTICLE 2 Meaning of Credit

For the purposes of these Articles, the expressions "Documentary Credit(s)" and "Standby Letter(s) of Credit" (hereinafter referred to as "Credit(s)"), mean any arrangement, however named or described, whereby a bank (the "Issuing Bank") acting at the request and on the instructions of a customer (the "Applicant") or on its own behalf,

i. is to make a payment to or to the order of a third party (the "Beneficiary"), or is to accept and pay bills of exchange (Draft(s)) drawn by the Beneficiary,

or

ii. authorizes another bank to effect such payment, or to accept and pay such bills of exchange (Draft(s)),

or

iii. authorizes another bank to negotiate, against stipulated document(s), provided that the terms and conditions of the Credit are complied with.

For the purposes of these Articles, branches of a bank in different countries are considered another bank.

 

Introduction: Article 2 contains a broad definition of the L/C in order to cover all documentary promises to pay. This broad definition shall ensure that the UCP are not limited to L/Cs. Article 2, which was revised in the 1993 revision, emphasizes the character of an L/C as so- called "primary liability" (footnote10) in order to clarify that the beneficiary, unlike with a suretyship, has a direct claim for satisfaction against issuing or confirming bank. Similar to Article 9 a, 9 b UCP 500, Article 2 is ambiguous, as it does nor prevent the erroneous conclusion, that the beneficiary has a claim against issuing or confirming bank even if the L/C is payable with a third party bank. This is incorrect (compare explanation Article 9 a, 9 b UCP 500).

 

The first sentence of Article 2 UCP 500 furthermore mentions the alternative -only relevant when a Standby is issued- that Credits can be issued not only at the request of a customer but on a bank's own behalf. To guarantee one's own performance is unusual, however the BGH expressly recognized this possibility (footnote11).

 

Article 2, sentence 1 UCP 500- Credit as a generic term: Article 2 UCP 500 subsumes under the term Credit and the Letter of Credit and the Standby. The intended expansion of the scope of application of the UCP does not change the fact that the majority of rules are inapplicable to Standbys and guarantee-like payment promises (compare introduction). As the passage "however named or described" clarifies, a Credit need not be designated as Credit. Similar to transport documents, the designation of a document is irrelevant. The important criterion is rather, the issuance of an unconditional documentary promise to pay.

 

Artice 2 (i) to (iii) UCP 500 - substance of a documentary promise to pay: Article 2 (i) to (iii) UCP 500 describes the three alternatives of a bank's performance obligation (payment, acceptance, negotiation) as follows:

 

Article 2 (i) UCP 500: Payment to or to the order of a third party (the "Beneficiary"), or acceptance and payment of bills of exchange: The 1993 revision of Article 2 (i) meant to emphasize the primary liability of issuing or confirming bank, regardless whether the Credit is payable with a another bank.

 

Article 2 (ii) UCP 500: Authorization of another bank to effect payment or accept and pay bills of exchange: This alternative provides for the employment of another bank, which is not liable towards the beneficiary, where the Credit is payable. Article 2 (ii) in connection with Article Article 2 (i) clarifies that issuing and confirming bank remain liable for the performance under the Credit when utilizing another bank. This is even the case in acceptance Credits, where issuing and confirming bank are liable not only for acceptance but also for payment (compare Article 10 a (iii) UCP 500).

 

Article 2 (iii) UCP 500: Authorization of another bank to negotiate: The 1993 revision introduced a separate provision for negotiation. Ever since negotiation is possible not only in connection with bills of exchange but also simply against presentation of documents

(compare the definition of negotiation in Article 10 b (ii) UCP 500). The 1993 definition of "negotiation" has led to various misunderstandings, which prompted the ICC to issue a so called position paper (footnote12). Now as before, negotiation consists of the purchase of documents, with or without issuance of a bill of exchange, whence the authorized bank deducts interim interest (compare explanation Article 10 b (ii) UCP 500).

 

Article 2, paragraph 1 UCP 500 - Stipulated documents of any kind triggering payment:

The presentation of documents is the essence of documentary promises to pay, irrespective whether L/C or Standby. This is the distinction to non-documentary payment promises, e.g. a guarantee, which are payable on first demand without presentation of documents. To facilitate the application of the UCP to all documentary promises to pay, i.e. L/Cs and Standbys, Article 2 UCP 500 only requires the presentation of "stipulated documents". In accordance with this wording, the stipulated documents need not be transport documents; rather, any document can be presented, as long as the UCP or stipulations agreed upon among the parties describe it in sufficient clarity and detail.

 

Expiry Date as an additional requirement for the validity of a Credit (Article 42 UCP 500): Article 2 UCP 500 only describes the various alternatives of a documentary promise to pay. It is mandatory however, for the validity of a Credit that it provides for an expiry date and a place for presentation of documents (see Article 42 UCP 500). A credit without expiry date is void. The authors believe that the failure to stipulate a place for presentation of documents is without consequence, since the documents can be presented to the bank where the Credit is payable (compare the difference between validity and usability at Article 9 UCP 500).

 

Article 2, last sentence UCP 500: The UCP do not contain a definition of the term "bank" but content themselves with the clarification that "branches of a bank in different countries are considered another bank". As the ICC elaborates (footnote13) :

"Another bank may therefore be a separate legal entity or part of the same legal entity as the first bank, provided that the two branches involved are situated in separate countries."

 

This has the following consequences:

To observe a time limit it is not sufficient to present the documents to the foreign branch when the Credit is payable at the domestic branch

 

If the foreign branch, used as "another bank", accepts document, the main bank can still refuse the documents as non-compliant, since it is not bound by the decision of its foreign branch.

 

The legal construction of Article 2, last sentence UCP 500 only applies to the applicability of the UCP and does not bear upon the determination of a venue" "This new classification "another bank" does of change position or exposure of the parties. " (footnote 15)

 

Article 3 UCP 500 Credits v. Contracts

ARTICLE 3 Credits v. Contracts

A. Credits, by their nature, are separate transactions from the sales or other contract(s) on which they may be based and banks are in no way concerned with or bound by such contract(s), even if any reference whatsoever to such contract(s) is included in the Credit. Consequently, the undertaking of a bank to pay, accept and pay Draft(s) or negotiate and/or to fulfill any other obligation under the Credit, is not subject to claims or defenses by the Applicant resulting from his relationships with the Issuing Bank or the Beneficiary.

B. A Beneficiary can in no case avail himself of the contractual relationships existing between the banks or between the Applicant and the Issuing Bank.

Article 3 a UCP 500 - Independence of Credit from underlying transaction: Article 3 a UCP 500 states that Credits and underlying transactions are separate: this is the essence of documentary payment promises. This separation establishes a Credit's liquidity function, according to which payment will be effectuated independent of the underlying transaction. According to German law a Credit is subject to the rules for abstract promises to pay according to paragraph 780 BGB. (footnote 16).

 

The English language version of the ICC describes the concept of independence as follows: "Credits, by their nature, are separate transactions for the sales or other contracts on which they may be based." The description concurs with the description of Standbys in Article 1.06 ISP 98 entitled "Nature of Standbys". In order to corroborate the independence of a Credit it is neither necessary to add supplements to the Credit language like "unconditional or abstract", "absolute", or "primary" nor is it required to have the bank waive its defenses or objections. The different interpretations of legal systems regarding the concept of independence do not show themselves in the positive definition of the separateness of the Credit obligation; rather, they reveal themselves in the opposite case, i.e. under which circumstances do national courts allow the piercing of the independence in case of fraud etc. (footnote18).

 

Article 3 a, sentence 1 UCP 500 - Reference to underlying transaction irrelevant: This provision clarifies, that a reference to the underlying transaction does not limit the Credit obligation. Such a reference, similar to the preamble in a bank guarantee, only serves to notify the beneficiary how to allocate a certain transaction and the corresponding Credit. (footnote19)

 

Article 3 a, sentence 2 UCP 500 - Applicant's defenses and claims not available to banks: The 1993 revision of the UCP introduced the unnecessary clarification, that a bank's obligation under a credit is not subject to claims or defenses of the Applicant, "resulting from his relationships with the Issuing Bank or the Beneficiary" (Article 3 a, sentence 2 UCP 500). Del Busto justifies the expansion of Article 3 as follows (footnote20):

"Unfortunately, this language [former version of Article] has encouraged Applicant-inspired litigation that interferes with the bank's payment undertaking when the terms and conditions of the Credit have been complied with".

Apparently del Busto refers to cases in which the Applicant was able to obtain temporary restraining orders or preliminary injunctions against banks. The clarification in this regard is welcome, however, it is not prone to modify the dissenting decisions of national courts.

The BGH for example has decided for a guarantee payable on first demand, which is equal to a Credit obligation, that a bank could set off its claims against the beneficiary 9e.g. arising from drafts issued by the Beneficiary) as long as these claims are liquid.

 

Article 3 b UCP 500 - Beneficiary not party to the contract between Applicant and issuing bank: Similar to an order for remittance, a contract to issue a Credit is a contract to the benefit of a third party. This is the reason that the Beneficiary cannot avail himself of internal agreements between Applicant and Issuing Bank, or between banks.

 

ARTICLE 4 Documents v. Goods/Services/Performances

In Credit operations all parties concerned deal with documents, and not with goods, services and/or other performances to which the documents may relate.

 

Handling of documents: Article 4 clarifies, once again, that the parties in a Credit transaction "deal with documents, and not with goods, services and/or other performances to which the documents may relate" (Article 4 UCP 500). This is just a repetition in other words of the independence principle laid down in Article 3 UCP 500. The express mention of services and/or other performances can be explained by the desire of the drafters of the 1993 revision, to extend the scope of application of the UCP to standbys. Under a standby the beneficiary is typically not required to present documents of title but other documents, reflecting the underlying transaction (footnote22).

 

ARTICLE 5 Instructions to Issue/Amend Credits

A. Instructions for the issuance of a Credit, the Credit itself, instructions for an amendment thereto, and the amendment itself, must be complete and precise.

In order to guard against confusion and misunderstanding, banks should discourage any attempt:

i. to include excessive detail in the Credit or in any amendment thereto;

ii. to give instructions to issue, advise or confirm a Credit by reference to a Credit previously issued (similar Credit) where such previous Credit has been subject to accepted amendment(s), and/or unaccepted amendment(s).

 

B. All instructions for the issuance of a Credit and the Credit itself and, where applicable, all instructions for an amendment thereto and the amendment itself, must state precisely the document(s) against which payment, acceptance or negotiation is to be made.

 

Article 5 a, sentence 1 UCP 500 - Complete and precise instructions: When a bank executes the instructions received under a Credit or examines the documents presented, it cannot exercise any discretion; similarly, paragraph 665 BGB does not entitle a bank to disregard certain passages. Since banks do not and cannot know the details of the underlying transaction, including special industry specific customs and usages, a bank is not able to foresee the importance of even small deviations (Principle of compliance (compare Article 13 UCP 500 footnote23)). To enable banks to abide by the principle of documentary compliance, Article 5 a requires, that the instructions be complete and precise. If instructions are ambiguous or incomprehensible a bank is not permitted to execute these instructions, rather the bank has to request the applicant to clarify (compare Article 12 UCP 500 "Incomplete or Unclear Instructions").

Article 5 a (i) UCP 500 - Avoid excessive detail: The reminder to avoid excessive detail targets the practice, to overcharge the Credit with conditions and provisions, which are irrelevant for the purpose of the Credit. To include page long technical details for an invoice is an example of the incriminated practice.

 

Article 5 a (i) UCP 500 - Avoid reference to Credit previously issued: The reference to a previously issued Credit is particularly ambiguous, when the original version of the Credit was amended. Before the 1993 revision Article 13 UCP 400 provided, that in these cases the reference was deemed to refer to the unamended original version of the Credit. Article 13 UCP 400 has been abolished and the ICC recommends to reject instructions for issuance, advise, or confirmation if the Credit referenced in the instructions has been amended (footnote25).

 

It is unclear how to interpret instructions which --in violation of Article 5 (ii) UCP 500 -- reference a "similar Credit". The ICC only points out the risk of interpretation:

"Alternatively, banks should understand the risks they are assuming if they interpret (or fail to interpret) the intent and instructions when agreeing to act on instruction to issue, advise or confirm "similar Credits". "(footnote26).

The interpretation of these instructions should be effectuated in accordance with the old Article 14 UCP 400, which stipulates that the reference is deemed to be made to the unamended, original Credit. Since this rule has been abolished, banks should in doubtful cases request the issuing bank to provide the necessary information.

 

Article 5 b UCP 500 Precise statement of documents: The admonition to precisely state the documents of a Credit is self evident. It is the consequence of the fact that a bank has to strictly follow an applicant's instructions and that in previous revisions of the UCP, banks had certain discretion when e.g. being presented with stale documents. However, since the 1993 revision banks, except for Article 37 b UCP 500 invoice amount exceeds Credit amount, no longer can exercise any discretion when being presented with documents.

In this context the authors want to mention the new Article 13 c UCP 500, according to which banks will disregard conditions, if the Credit does not state the "document(s) to be presented in compliance therewith" (compare explanation Article 13 c UCP 500).