Letters of Credit from Basics and Beyond to the Current Issues

Presentations by Geoffrey Wynne and Tom Glinka

Sullivan & Worcester UK LLP

on 15 June 2017

At Pinners Hall, 105-108 Old Broad Street,

London, EC2N 1EX

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What this talk will cover Letter of credit (LC) and its uses

How documentary and standby LCs work

The bank roles and what to look out for › Confirmations › Silent Confirmations › Documenting these

Synthetic LCs

Syndicating LCs

Recent developments in case law

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Documentary credits – basic elements Who, why, what, where and when

› Who: name of beneficiary › Why: applicant and the underlying contract › What: the documents needed to make a claim › Where: place for presentation › When: expiry date

Documents to be presented - complying presentation

Examination of documents

Letter of credit can be available by › Sight payment › Deferred payment › Others

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Documentary credit - issuance

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Buyer’s bank

Seller’s bank

Buyer Seller

COUNTRY A COUNTRY B

1. Commitment to deliver

2. Commitment to pay

5. Advice of issue and confirmation of LC

4. Documentary LC issued

3. Application of LC and counter-indemnity

Documentary credit - claim

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Buyer’s bank

Seller’s bank

Buyer Seller

COUNTRY A COUNTRY B

1. Shipment of goods

4. Payment under LC

6. Reimbursement

7. Claim under counter-indemnity

8. R

eimb

ursem

ent

3. Checks claim in compliance with credit

5. Forwarding of documents and reimbursement request

2. Presentation 9. Forwarding of documents

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Documentary credits – key elements UCP 600

Documents to be presented

Examination of documents

Letter of credit can be available by › Sight payment › Deferred payment › Others

Governing Law and Jurisdiction › Often not there

Consider all these in light of payment obligations

Documenting the arrangements › One off or facility › Taking security

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Standby letter of credit - issuance

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Buyer’s bank

Seller’s bank

Buyer Seller

COUNTRY A COUNTRY B

1. Commitment to deliver

5. Advance payment

2. Application for standby LC and counter-indemnity

3. Standby LC issued

4. Advice of issue and confirmation of standby LC

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Standby letter of credit - claim

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Buyer’s bank

Seller’s bank

Buyer Seller

COUNTRY A COUNTRY B

1. Seller fails to deliver

7. Claim under counter-indemnity

6. Reimbursement

4. Payment under standby LC

2. Claim under standby LC

3. Checks claim in compliance with credit

5. Notice of claim and reimbursement request

8. Reimbursement

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Standby letter of credit – key elements LCs tend to be short documents

Who, why, what, where and when › Who: name of beneficiary › Why: applicant and the underlying contract › What: the documents needed to make a claim › Where: place for presentation › When: expiry date

Subject to uniform rules: UCP 600 or ISP98

Governing law and jurisdiction clause › Often not there

What if payment has to be made?

Documenting the arrangements › One off or facility › Taking security

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How it all starts Applicant

› What does it want? › Why does it need letter of credit?

Is it to pay for something? › Documentary

Is it to cover an unexpected event? › Standby

Beneficiary

Does it matter? › How to be reimbursed

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Other commonly used terms Discounting

Negotiation

Import and export credits › Trade debt?

Red clause, green clause credits

Evergreen credits

Revolving, escalating, de-escalating credits

Back-to-back credits

Transferable credits

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Transferable credit – claim

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Buyer’s bank

Seller’s bank

Buyer Seller 1. Shipment of goods

4. P

aymen

t of p

art claim

6. Reimbursement

7. C

laim

reimb

ursem

ent

9. Forw

ards

docu

men

t

3. Checks claim is compliant

5. Sending of documents with substituted invoice

2. P

resentation

8. R

eimb

ursem

ent

Middleman

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Some key bank roles in letters of credit Issuing bank

› At request of applicant › What should it check?

Confirming bank › At request of beneficiary › Makes payment › Collects from issuing bank

Note affect of sanctions etc. › What if different rules apply to Issuing Bank and Confirming Bank?

Avoid being caught in the middle

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Silent Confirmations Request by Beneficiary

Outside UCP 600/ISP 98

Document separately

Important to take rights to claim against Issuing Bank

Different situations

Taking security

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Structured (synthetic) letter of credit

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Confirming bank

Issuing bank

Beneficiary Applicant

5. Shipment

2. R

equ

est to

issue LC

3. 360 days deferred LC issuance

4.

LC a

dvi

sin

g

7.

Dis

cou

nt

un

der

LC

36

0 d

ays

fun

ds

1. Purchase contract 360 days

6.

Co

py

do

cs.

Issuing Bank 8. Repayment on due date (after

360 days)

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Synthetic letters of credit What about synthetic letters of credit?

› Very useful funding for Issuing Bank › Structure should be simple › Why would Issuing Bank challenge it? › Is it trade debt? › Is it working capital and does it matter?

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Syndicating a letter of credit One or more issuing banks?

› Usually one

Document behind the letter of credit › Participation agreement(s)

Points for a syndicated participation agreement › Voting › Liability - sharing?

Who checks the documents?

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Recent cases Several relevant recent cases:

Petrosaudi Oil Services (Venezuala) Ltd v Novo Banco SA[2017] EWCA Civ 9

National Infrastructure and Development Co. Ltd v BNP Paribas [2016] EWHC 2508

National Infrastructure and Development Co. Ltd v Banco Santander S.A. [2016] 2990

Deutsche Bank AG, London v CIMB Bank Berhad [2017] EWHC 1264 (Comm)

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The Petrosaudi case (1) - Facts Petrosaudi Oil Services (Venezuala) Ltd v Novo Banco SA & Others [2017] EWCA Civ 9

› Petrosaudi Oil Services (Venezuela) Ltd (POS) supplied drilling services and equipment to PDVSA Servicios SA (PDVSA), a Venezuelan state entity

› Drilling contract was governed by Venezuelan law, with payment due under that contract within 30 days of invoice date on a “pay now argue later” basis (subject to dispute resolution)

› SBLC governed by English law was granted in favour of POS by Novo Banco in relation to the payments due from PDVSA – Drilling contract said that the SBLC was to secure payment and guarantee PDVSA’s performance

› Invoices issued but not paid by PDVSA

› Invoices disputed; arbitration determined contract provisions regarding “pay now argue later” in breach of Venezualan law and therefore null and void

› Arbitrators determined POS could not require payment under the underlying contract until provisions of Venezualan law satisfied but the question of whether claims could be made under SBLCs should be decided by the English courts

› Petrosaudi started high court proceedings in England and claimed under the letter of credit stating monies due and payable under the contract with demand being issued by General Counsel

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The Petrosaudi case (2) – High Court Decision Petrosaudi Oil Services (Venezuala) Ltd v Novo Banco SA & Others [2017] EWCA Civ 9

› Arbitrators ruling meant that PDVSA was not “obligated to pay” within the meaning of the SBLC

› Invoice payments have to be due immediately at time of demand under the SBLC › Obligation (or potential obligation) to make payments in the future or potential

payments did not meet requirements › Judge rejected the evidence of the GC where he stated his legal interpretation of

the arbitration ruling and the meaning of the wording of the SBLC › Stated that the signatory did not believe payment was due in the obvious way

the claim statement intended › As a result the statement was false or reckless so fraudulent and the fraud

exception applied

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The Petrosaudi case (3) – Court of Appeal Decision Petrosaudi Oil Services (Venezuala) Ltd v Novo Banco SA & Others [2017] EWCA Civ 9

› SBLC and underlying contract were different contracts with different governing laws and different parties

› Construction of the SBLC should not be viewed in the context of the construction of the underlying contract

› Also important to consider the commercial background and PDVSA poor reputation for payment, which the SBLC was entered into specifically to mitigate

› Uncontested evidence that the SBLCs functions was to ensure payment despite the specific Venezualan law provision that prevented payment under the underlying contract

› SBLC did not require evidence to accompany demand, only unpaid invoice and evidence of receipt

› The relevant Venezualan law provision did acknowledge pre-existence of payment obligation (as asserted in the GCs reasoning given in his evidence)

› Judge wrong to find that no payment obligation could arise until the procedure set out in Venezualan law was followed 21

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The Petrosaudi case (3) – Court of Appeal Decision Petrosaudi Oil Services (Venezuala) Ltd v Novo Banco SA & Others [2017] EWCA Civ 9

› GC could honestly certify that PDVSA was obligated under the underlying contract to pay amount demanded

› No fraud › Uncomfortable with judge’s findings of fraud based on the GC taking a different

view from the judge on what was essentially a matter of legal interpretation

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The BNPP case (1) - Facts National Infrastructure and Development Co. Ltd v BNP Paribas [2016] EWHC 2508

The National Infrastructure and Development Company (NIDCO), a state owned enterprise in Trinidad and Tobago, entered into a contract with a Brazilian contractor OAS Construtora for the construction of a highway

BNP and Santander (the Santander case is dealt with in a later slide) issued a number of SBLCs subject to English law in relation to the project, which were counter guaranteed by a BNP subsidiary in Brazil, who also received guarantees from OAS

OAS entered into insolvency proceedings in Brazil and the contract with NIDCO was terminated and arbitration proceedings commenced as a result

OAS obtained interim injunctions in Brazil which prevented the BNP companies from paying out under the SBLCs

As the SBLCs were governed by English law, NIDCO brought proceedings in the High Court in London and applied for Summary Judgment

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The BNPP case (2) - Decision National Infrastructure and Development Co. Ltd v BNP Paribas [2016] EWHC 2508

BNP accepted that it had no English law defence and argued that judgment should be deferred until the outcome of the insolvency proceedings in Brazil otherwise BNP would be in breach of the interim injunctions

If judgment was in fact granted in England, then they argued a stay of execution should be granted

The court rejected these argument and said that ‘’if a party who had opened a letter of credit could defeat the bank's obligation to pay by obtaining an injunction against the bank in its home jurisdiction’’, this would defeat the whole commercial objective of SBLCs

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The Santander case (1) - Facts National Infrastructure and Development Co. Ltd v Banco Santander S.A. [2016] 2990

The facts of this case are repeated on the BNP slide

NIDCO made demands under the standby letters of credit in the form specified in them, stating that "the amount of … is due and owing to us by the Contractor".

A court in Brazil, where Santander had a subsidiary, issued an injunction restraining payment under the standby letters of credit.

NIDCO sought summary judgment against Santander. Santander sought a stay of execution if summary judgement is ordered, given the Brazilian injunction.

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The Santander case (2) - Decision National Infrastructure and Development Co. Ltd v Banco Santander S.A. [2016] 2990

Santander argued that it does not have to make payment under the standby letters of credit because NIDCO gave false notification in the demands in that they were made recklessly as to what was due and owing, and that the fraud exception should engage in this case because: NIDCO certified that sums were "due and owing" from the contractor but no such

sums were due and owing because the sums claimed were damages and those damages had not yet been liquidated or awarded by a tribunal. Unless and until they were they could not be said to be payable.

NIDCO knowingly or recklessly overclaimed under the standby letters of credit.

The law should recognise a different approach to standby letters of credit used to settle performance obligations from the approach to letters of credit used to settle primary payment obligations. For standby letters of credit used to settle performance obligations there should be an exception for unconscionable conduct alongside the recognised fraud exception.

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The Santander case (2) - Decision National Infrastructure and Development Co. Ltd v Banco Santander S.A. [2016] 2990

It was held that, in certifying that amounts were due and owing, what mattered was the beneficiary's honest belief that amounts were due and owing.

It was irrelevant whether, as a matter of law, the sums claimed were determined to be due and owing. The wording of the demands was not the same as that in other decided cases, but it was noted that the beneficiary did not have to state in the demand that a tribunal had determined the amounts to be due and owing or that it had been advised that the amounts were due and owing as a matter of law.

Santander’s arguments in relation to the beneficiary overclaiming and the fraud exception being developed to cover unconscionable conduct by the beneficiary were also rejected by the court.

Summary judgment was granted and Santander ordered to pay. It is an important principle that standby letters of credit must work in accordance with their terms, and that includes payment on time.

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Santander and BNP cases - Conclusion If a demand under a standby letter of credit appears on its face to comply with the

terms of the standby letter of credit (and the requirements of any ICC rules to which it is expressed to be subject), English law has only very limited exceptions to the rule that the issuing bank must pay against an apparently compliant demand.

These exceptions include where there is: illegality under local law in the place of payment under the standby letter of

credit; or fraud in procuring the issue of the standby letter of credit, or a fraudulent

demand by the beneficiary – the “fraud exception”.

It is important to remember the limited ambit of the fraud exception.

The courts generally remain reluctant to expand the scope of exceptions to the autonomy principle.

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The DB case (1) - Facts Deutsche Bank AG, London v CIMB Bank Berhad [2017] EWHC 1264 (Comm)

› CIMB was the issuing bank and DB the confirming bank in relation to a number of commercial LCs

› Presentations were made by the beneficiary to DB who forwarded the documents on the issuing bank stating that they had paid and requesting reimbursement

› CIMB refused to pay on the basis of alleged documentary discrepancies › However, a preliminary point arose as to whether DB was required to prove to

CIMB that it had paid the beneficiary before it was entitled to reimbursement under article 7(c) of UCP600

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The DB case (2) - Decision Deutsche Bank AG, London v CIMB Bank Berhad [2017] EWHC 1264 (Comm)

› DB argued as a point of principle that: an issuing bank was not entitled to delve into the detail of the arrangements

between a confirming bank and its customer, the beneficiary and must rely on the confirming banks confirmation to the issuing bank that it had paid;

to require a confirming bank to prove to the issuing bank that it had made payment to the beneficiary in respect of every LC before it was entitled to receive reimbursement it would go against the cash principle and had the potential cause “chaos” in the letter of credit business

› Judge held that a confirming bank was required to prove payment if requested by the issuing bank

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Future dates for your diary:

Breakfast seminars 2017

27 July 2017 28 September 2017

26 October 2017 23 November 2017

14 December 2017

Anniversary Party 16 November 2017

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Geoffrey L Wynne Partner Geoffrey Wynne is head of Sullivan & Worcester’s London office and also head of its Trade & Export Finance Group. He has extensive experience in banking and finance, specifically trade and structured trade and commodity finance. He also advises on corporate and international finance, asset and project finance, syndicated lending, equipment leasing and workouts and financing restructuring.

Geoff is one of the leading trade finance lawyers and has advised extensively many of the major trade finance banks, multilateral financers and companies around the world on trade and commodity transactions in virtually every emerging market including CIS, Far East, India, Africa and Latin America. He has worked on many structured trade transactions covering such diverse commodities as oil, nickel, steel, tobacco, cocoa and coffee. He has worked on warehouse financings in many jurisdictions and advised on how to structure involving warehouse operators and collateral managers. He has also advised on ownership structures and repos for commodities and receivables financings.

Geoff sits on the editorial boards of a number of publications and is a regular contributor and speaker at conferences. He is also the editor of and contributor to The Practitioner’s Guide to Trade and Commodity Finance published by Sweet & Maxwell and A Guide to Receivables Finance, a special report from TFR published by Ark.

Sullivan & Worcester UK LLP Tower 42 25 Old Broad Street London EC2N 1HQ

T +44 (0)20 7448 1001 F +44 (0)20 7900 3472 gwynne@sandw.com

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Tom Glinka Senior Associate

Tom Glinka is a senior associate in the London office. He is a banking lawyer specialising in structured trade and commodity finance, commodity ownership structures, trade instruments, receivables structures and emerging markets finance. He has extensive experience advising financial institutions and borrowers across a wide range of jurisdictions in Africa, Asia, South America, CIS and Europe. Commodities he has been involved in financing include, amongst others, oil, gold, aluminium, copper, steel and agricultural products. Tom has also undertaken a secondment with a major international bank.

Sullivan & Worcester UK LLP Tower 42 25 Old Broad Street London EC2N 1HQ

T +44 (0)20 7448 1007 F +44 (0)20 7900 3472 tglinka@sandw.com

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Awards & Recognition TFR “Best Law Firm in Trade Finance”

Trade & Forfaiting Review (TFR) named Sullivan & Worcester "Best Law Firm in Trade Finance" in its 2014, 2015 and 2016 TFR Excellence Awards GTR “Best Law Firm 2015 Poll”

Sullivan & Worcester UK LLP was top ranked firm in the Global Trade Review (GTR) Best Law Firm 2015 poll The Legal 500 UK 2016

Sullivan & Worcester UK LLP was ranked in the following category in The Legal 500 UK:

› Trade Finance (Tier 1)

Chambers UK 2016

Chambers UK ranked Sullivan & Worcester UK LLP, along with Geoffrey Wynne and Simon Cook in the following area:

› Commodities: Trade Finance (UK-wide)

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© 2017 Sullivan & Worcester Sullivan & Worcester is the collective trade name for an international legal practice. Sullivan & Worcester UK LLP is a limited liability partnership registered in England and Wales under number OC381549 and is a practice of registered and foreign lawyers and English solicitors. Sullivan & Worcester UK LLP is authorised and regulated by the Solicitors Regulation Authority (“SRA”). The term partner is used to refer to a member of Sullivan & Worcester UK LLP. A list of the names of all the partners is available for inspection at our registered office, Tower 42, 25 Old Broad Street, London, EC2N 1HQ. Please see sandw.com for Legal Notices, including further information on our professional obligations. This presentation is not designed to provide legal or other advice and you should not take, or refrain from taking, action based on its content. We are providing information to you on the basis you agree to keep it confidential. If you give us confidential information but do not instruct or retain us, we may act for another client on any matter to which that confidential information may be relevant.

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