Relationships in and around Letters of Credit and What to Watch Out For

Presentations by Geoffrey Wynne and Marian Boyle

Partners, Sullivan & Worcester UK LLP

on 23 February 2017

At Pinners Hall, 105-108 Old Broad Street,

London, EC2N 1EX

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What this talk will cover What a letter of credit (LC) is and its uses

How documentary and standby LCs work

Synthetic LCs

The different ways LCs can be made available

The contractual matrix

What to look out for in your agreements

The missing legal links

Recent cases affecting this

Summary

Issues that can lead to dispute resolution headaches (Marian Boyle)

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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 – basic 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 and ISP98

Governing law and jurisdiction clause › Often not there

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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 – some bank roles Issuing bank

Advising bank

Confirming bank

Nominated bank

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Documentary credits – basic elements Same as for standby LCs except only UCP 600 is suitable

Documents to be presented differ

Examination of documents

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

Consider all these in light of payment obligations

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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

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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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What makes a letter of credit so useful?

Irrevocable payment undertaking given (usually) by a bank

Payment made against documents presented in accordance with the terms of the credit

Independent of the underlying transaction

Documentary credits are payment instruments but can be used as financing instruments

Possibility to delay (defer) payment

Standby LCs are credit support or a means of shifting the financial burden in case of a dispute in the underlying transaction

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Contractual matrix UCP and ISP fully cover relationships between the banks having

different roles

Beneficiary there by implication (receive payment against presentation)

Applicant has no role in this process (except starting it)

Look at what you should expect/obtain from applicant and beneficiary in these structures

Have recent cases upset matters?

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The relationships Applicant and Issuing Bank

Issuing Bank and Confirming Bank

Confirming Bank and Beneficiary

Above are key examples

Each could be governed by a different law unless you expressly agree otherwise

Standard position is not to have an express governing law or submission to jurisdiction in “simple” letter of credit

No space in SWIFT message for example

Consider different stance for the more complex

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The Applicant A simple application form

› Specific to the issue › Agreement to reimburse › Indemnity

Letter of credit issuance agreement › Mechanics to set out requirement › Agreement to reimburse › Possible conversion to a loan › Indemnity

How to protect the issuing bank? › Security › Cash backed

What if it goes wrong? › Discrepancies › Injunctions – should you prevent them? › Fraudulent claim

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The Beneficiary What are you doing for the beneficiary?

Confirming Bank? › Have separate agreement?

Collecting Bank? › Rely on collection rules?

Discounting deferred payment? › Discounting agreement

Consider who is taking non payment (by Issuing Bank) risk › Indemnity from beneficiary?

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The Issuing Bank Should Confirming Bank just rely on UCP?

Who is taking presentation risk?

UCP 600 makes it clear? › Is Article 7(c) enough?

Still might have Applicant encouraging Issuing Bank on raising discrepancies

What if Applicant cannot pay? › Why should Confirming Bank lose out?

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Sharing the risk Silent confirmations

What is it?

Beneficiary has “comfort” of being paid

Outside Rules

“Confirming” Bank needs protection to pursue Issuing Bank › How to achieve this

Using Participation Agreements (MRPAs) › English law BAFT and the fraud exception – (see Section II) › Who takes the risk? › Should it be the checker (Grantor) or risk sharer?

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Using a letter of credit in different ways

Much of the above relates to documentary letters of credit

The issue for a standby letter of credit › Generally simple demand › Less room for manoeuvre

What about synthetic letters of credit? › Very useful funding for Issuing Bank › Structure should be simple › Why would Issuing Bank challenge it? › Is it the trade debt? › Or is it working capital and does it matter?

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The use and abuse of discrepancies Many (most) documentary letters of credit have discrepancies

Some are so minor and can be ignored › BUT take care

Some are waived by the Applicant most of the time

Remainder are usually the result of a breakdown of relations between Applicant and Beneficiary

Sometimes the Issuing Bank does not want to pay because the Applicant has no money

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The use and abuse of the fraud exception

Banco Santander v BNP Paribas caused a rethink

UCP 600 changed timing to determine fraud

Fraud needs to be on face of document

Argument still used by an Issuing Bank not wanting to pay

How to “catch” a fraudster?

Still very narrow exception

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Recent Case Law

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National Infrastructure Development Co Ltd v Banco Santander SA [2017] Fraud exception – judgment upheld by Court of Appeal.

BACKGROUND:

The defendant bank, Banco Santander (Santander) issued standby letters of credit to the claimant, (N), in relation to a construction contract between N and a contractor, governed by the law of Trinidad and Tobago

N claimed the contractor abandoned the project and arbitration between the parties commenced. N 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

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

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National Infrastructure Development Co Ltd v Banco Santander SA [2017] Santander argued that it does not have to make payment under the

standby letters of credit because N 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: › N 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

› N knowingly or recklessly over claimed 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 the former, there should be an exception for unconscionable conduct alongside the recognised fraud exception

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National Infrastructure Development Co Ltd v Banco Santander SA [2017] JUDGMENT:

The court 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 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 over claiming 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 was ordered to pay. Standby letters of credit must work in accordance with their terms, and that includes payment on time

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National Infrastructure Development Co Ltd v BNP Paribas [2016] Autonomy of letters of credit

BACKGROUND:

The background facts of this case are the same as the previous case between National Infrastructure Development Co Ltd (N) and Santander. It also involved demands by N, of Trinidad and Tobago, for payment under SBLCs issued in its favour by various international banks at the request of a Brazilian contractor, (OAS). Just as in the previous case, OAS filed for judicial reorganisation in Brazil. Following this, N terminated the construction contract, referred disputes under that contract to arbitration, and served demands under the SBLCs. It then emerged that the Brazilian courts had granted OAS an injunction restraining the various banks from paying under the SBLCs (the Brazilian Injunction)

BNP Paribas (BNPP) had issued SBLCs in favour of N to secure advance payments made to OAS and to provide credit support for OAS's performance obligations under the construction contract. The amounts demanded were not paid and N sought judgment for those amounts in the English courts

Under Brazilian law, BNPP risked a penalty of 10 per cent of the amount of the SBLCs if it paid out in breach of the Brazilian Injunction. Did the Brazilian Injunction give BNPP grounds to refuse to pay under the SBLCs as a matter of English law?

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National Infrastructure Development Co Ltd v BNP Paribas [2016] JUDGMENT:

Despite the injunction against BNPP and the 10% penalty for its breach, the court held 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 undermine the commercial purpose of letter of credit transactions

BNPP was therefore ordered to pay

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Petrosaudi Oil Services (Venezuela) Ltd v Novo Banco SA and others [2017] BACKGROUND:

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POS PDV

Novo Banco

Supply contract

for drilling services

for security of payment of

invoices issued by POS

LC

(LC opened for PDVSA, a Dutch

company and part of the PDV group)

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Petrosaudi Oil Services (Venezuela) Ltd v Novo Banco SA and others [2017] Fraud exception

BACKGROUND:

The claimant, Petrosaudi Oil Services (Venezuela) Ltd (POS), a Barbados company, supplied oil rig drilling services to the Second Defendant, PDVSA Servicios SA, a Venezuelan company (PDV), pursuant to a written International Daywork Drilling Contract (the Contract) governed by Venezuelan law

As required by the Contract, a standby Letter of Credit (the LC) was issued in favour of POS by the first defendant, Novo Banco SA, a Portuguese bank (the Bank), as security for payment of invoices issued by POS

The LC was opened for the account of the third defendant, PDVSA Services BV, a Dutch company and part of the same group as PDV

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Petrosaudi Oil Services (Venezuela) Ltd v Novo Banco SA and others [2017] BACKGROUND:

POS issued invoices to PDV, for services under the Contract. The Contract provided that PDV would pay POS invoiced amounts regardless of whether it disputed the invoices and pending resolution of any dispute

PDV disputed the invoiced amounts. An arbitral tribunal found that the relevant provisions of the Contract were null and void as they contravened Venezuelan law which provided that a state entity would only pay after it had approved an invoice following a prescribed approval process

Therefore, payment under the invoices was not due at the time – “pay now, argue later” was inconsistent with Venezuelan law and therefore unenforceable

In light of the arbitration ruling, PDV argued that the demand certifying that PDV was "obligated to the beneficiary to pay the amount demanded under the drilling contract" was fraudulent

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Petrosaudi Oil Services (Venezuela) Ltd v Novo Banco SA and others [2017]

JUDGMENT:

The High Court held that a presentation under the letter of credit was made falsely where the sums demanded were not due and payable immediately under the underlying contract at the time of the presentation. It found that since the signatory of the presentation knew that payment was not due at the time, the fraud exception applied to prevent payment under the letter of credit

This judgment was overturned by the Court of Appeal, who held that: › the certificate presented to the bank was true and the judge had been wrong to conclude

otherwise;

› the fact that PDV was currently prevented by Venezuelan law from discharging its payment obligations under the drilling contract did not mean, in context and bearing in mind the commercial purpose of the SBLC, that PDV was not under any present obligation to pay sums properly invoiced under the drilling contract; and

› it therefore followed that the certificate was not fraudulently made

The Bank was ordered to pay the sum of $129.8 million to POS

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Bulgrains & Co Limited v Shinhan Bank [2013]

Discrepancies

The court held that even minor discrepancies (which, in this case was a missing ampersand), which may seem to the presenter to be trivial or insignificant, may entitle the issuing or confirming bank to refuse to honour the presentation, potentially leaving the presenter with no payment security if he is unable to re-present conforming documents before the expiry of the credit

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Some other thoughts on the wording of letters of credit Keep the documentation required clear and simple

Deferred payment undertakings › How to document?

Avoid allowing “subjective” sanctions wording

See lack of governing law etc as if “the norm” › Principle should have limitation

Insert governing law (and perhaps jurisdiction) › Large amount and importance › Complicated letter of credit › Using in a financing structure

Document relationship with parties outside the letter of credit carefully

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Summary Letters of credit are still autonomous payment undertakings

› Note: limited exceptions (fraud, illegality) › Fit this into other legal issues like sanctions, financial crime, money laundering

Banks can seek some protection in agreements with their own customer and other parties

Take care on how to deal with “correspondent banks”

Remember you can reflect different relationships through separate bilateral contracts

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Dispute Resolution Issues

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Consequences of having no agreed governing law

LCs bundle of separate contracts, e.g. › Issuing bank and confirming bank › Confirming bank and beneficiary › Issuing bank and applicant

UCP does not contain any governing law provisions

LCs generally cross-border thus multi-jurisdictional

Governing law of the various LC relationships likely to be different

Determining the substantive law, in each bi-lateral contract, absent express choice of law agreement, likely to be complex

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Governing/substantive law Governing law specifies the system of law that applies in the interpretation

of the contracts

Substantive law of the various LC relationships determined by the “conflict of law” rules

Conflict of law rules: test that courts will apply to determine the substantive law of a contract

Vary from one country to another

English law test – to which jurisdiction is the LC contract most closely connected?

Potential for conflicting decisions from courts in different jurisdictions

Disputes about the appropriate governing law - lengthy and expensive

Bargaining leverage

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Consequences of having no jurisdiction clause Governing law does not specify how the disputes are to resolved -

e.g. courts or arbitration

Absent a jurisdiction clause, arbitration can only take place by agreement - inherently consensual (and generally private) method of DR

For LCs with no effective jurisdiction clause, the appropriate forum for the settlement of disputes determined by the rules of private international law

Basic rule of jurisdiction under the European regime (subject to a number of exceptions) - a defendant must be sued in the courts of its domicile/statutory seat or principal place of business

Outside European regime, courts in different jurisdictions likely to adopt a different approach

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Jurisdiction clause (cont) Common law rules based on:

› Service of process (within/outside the jurisdiction) › Submission to the jurisdiction › Appropriate /natural forum - location for the case to be suitably tried

Service within the jurisdiction preferable - court will only decline jurisdiction in exceptional cases - hence boiler plate service of suit clauses

Deciding on the most natural forum › Availability of witnesses › Law governing the transaction › Where the parties carry on business

Risk of inconsistent decisions - if proceedings have been commenced elsewhere - a significant consideration

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Jurisdiction where defendant served out of the jurisdiction

Permission of the court must be obtained

Requirements: › Case must fall within one of the recognised jurisdictional “gateways” › The claim has reasonable prospect of success › England is the proper place to bring the claim - clearly the most appropriate

forum

Jurisdictional gateways include fact that contract governed by English law or made within the jurisdiction

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LCs - dispute issues- the summary

Resolving dispute where contracts have no substantive law, service or jurisdiction clauses (while an accepted commercial risk) may be problematic

Opportunity to resolve dispute by arbitration severely limited

Risks of counterparty forum shopping for “friendlier” jurisdictions

Jurisdictional/forum challenges

Uncertainty + complexity = cost and delays

Negotiation leverage

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Current dates for your diary:

Breakfast seminars 2017

23 March 2017 27 April 2017

25 May 2017 21 June 2017

27 July 2017 28 September 2017

26 October 2017 23 November 2017

14 December 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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Marian Boyle Partner

Marian Boyle is a partner in our London office and heads the UK insurance and disputes practices working closely with the firm’s established trade and export finance team offering advice on insurance, risk management and commercial dispute resolution.

With over 20 years' experience, Ms. Boyle advises banks, insurance brokers, investment funds, government agencies and corporates on commercial insurance arrangements which support structured trade, commodity and pre-export financing as well as corporate finance, energy, property, M&A and outsourcing transactions. She also drafts and interprets insurance policies and advises on the use of insurance by credit institutions and investment firms as credit risk mitigation for capital adequacy purposes under the Capital Requirements Regulation.

Marian’s contentious experience includes advising clients in relation to disputes arising from trade credit, professional negligence and transactional disputes. These disputes are often international in nature and result in large-scale, highly complex multi-party litigation and arbitrations.

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

T +44 (0)20 7448 1004 F +44 (0)20 7900 3472 mboyle@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)

www.sandw.com

Offices Boston Sullivan & Worcester LLP One Post Office Square Boston, MA 02109 Tel: 617 338 2800 Fax: 617 338 2880

London Sullivan & Worcester UK LLP Tower 42 25 Old Broad Street London EC2N 1HQ Tel: +44 (0)20 7448 1000 Fax: +44 (0)20 7900 3472

New York Sullivan & Worcester LLP 1633 Broadway New York, NY 10019 Tel: 212 660 3000 Fax: 212 660 3001

Washington, D.C. Sullivan & Worcester LLP 1666 K Street, NW Washington, DC 20006 Tel: 202 775 1200 Fax: 202 293 2275

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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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Relationships in and around Letters of Credit and What to Watch Out For What this talk will coverStandby letter of credit - issuanceStandby letter of credit - claimStandby letter of credit – basic elementsDocumentary credit - issuanceDocumentary credit - claimDocumentary credits – some bank rolesDocumentary credits – basic elementsStructured (synthetic) letter of credit What makes a letter of credit so useful?Contractual matrixThe relationshipsThe ApplicantThe BeneficiaryThe Issuing BankSharing the riskUsing a letter of credit in different waysThe use and abuse of discrepanciesThe use and abuse of the fraud exceptionSlide Number 21National Infrastructure Development Co Ltd v Banco Santander SA [2017]National Infrastructure Development Co Ltd v Banco Santander SA [2017]National Infrastructure Development Co Ltd v Banco Santander SA [2017]National Infrastructure Development Co Ltd v BNP Paribas [2016]National Infrastructure Development Co Ltd v BNP Paribas [2016]Petrosaudi Oil Services (Venezuela) Ltd v Novo Banco SA and others [2017]Petrosaudi Oil Services (Venezuela) Ltd v Novo Banco SA and others [2017]Petrosaudi Oil Services (Venezuela) Ltd v Novo Banco SA and others [2017]Petrosaudi Oil Services (Venezuela) Ltd v Novo Banco SA and others [2017]Bulgrains & Co Limited v Shinhan Bank [2013]Some other thoughts on the wording of letters of creditSummaryDispute Resolution IssuesConsequences of having no agreed governing lawGoverning/substantive lawConsequences of having no jurisdiction clause�Jurisdiction clause (cont)Jurisdiction where defendant served out of the jurisdiction LCs - dispute issues- the summaryCurrent dates for your diary:�Geoffrey L Wynne�PartnerMarian Boyle�PartnerAwards & RecognitionSlide Number 45