Bankers risk in paying for oil cargoes against letter of indemnity for missing Bills of Lading
[14 March 2008]
In the oil (paper) trade, Bills of Lading need to be physically checked and endorsed following each transfer of title, possibly along a chain of buyers and banks. The consequence is that in short-sea trades where voyage time takes just a few days, the cargoes arrive at the port of discharge long before the Bills of Lading. The commodity traders found a way to deal with this matter by offering Letters of Indemnity both to carrier and buyer. The letter of indemnity in favour of carrier is for discharge of cargo without the presentation of an original Bill of Lading, whilst the letter of indemnity in favour of buyer is to assure him that he will receive the Bills of Lading latter on.
On its turn, a banker financing oil imports needs to ensure that letter of indemnity for missing Bills of Lading is addressed to the financing bank rather than actual buyer and that the letter of indemnity contains the seller’s undertaking that the full set of Bills of Lading will be sent to the bank not to the buyer because the bank is making the payment not the buyer.
The importance of this matter has been recently underlined in a British Court litigation involving the commodity trading company Trafigura and Korean bank Kookmin Bank (Trafigura Beheer BV vs. Kookmin Bank Co (2006) EWHC 1450). Trafigura bought an oil cargo from Pertamina PT, an Indonesian oil company, for re-sale to Huron in Korea. For this purpose Trafigura voyage chartered the vessel “Shanghai” through its subsidiary in Singapore from Morelia Overseas Inc. to carry the cargo from Indonesia to Korea. Trafigura requested Huron to pay by letter of credit.
The importance of this matter has been recently underlined in a British Court litigation involving the commodity trading company Trafigura and Korean bank Kookmin Bank (Trafigura Beheer BV vs. Kookmin Bank Co (2006) EWHC 1450).
Trafigura bought an oil cargo from Pertamina PT, an Indonesian oil company, for re-sale to Huron in Korea. For this purpose Trafigura voyage chartered the vessel “Shanghai” through its subsidiary in Singapore from Morelia Overseas Inc. to carry the cargo from Indonesia to Korea. Trafigura requested Huron to pay by letter of credit.
The letter of credit issued by Huron's bank required that "Bills of Lading be issued to or endorsed to the order of Kookmin Bank, Seoul, Korea (issuing bank)". The letter of credit also stipulated that in the absence of Bills of Lading the payment was to be effected against the Commercial Invoice and Letter of Indemnity issued by Trafigura in favour of Huron.
Upon completion of loading, Bills of Lading were issued indicating Pertamina as shipper.
While preparing the shipping documents for presentation to the negotiating bank, an employee in Trafigura’s Singapore office noticed a series of discrepancies in the references to loading port, discharge port and freight notations in the Bills of Lading. Furthermore, the Bills of Lading were made out to order of the negotiating bank (ANZ Bank London Branch) instead of the issuing bank (Kookmin Bank Seoul) as was required by the letter of credit. To avoid the rejection of Bills of Lading for these discrepancies, Trafigura presented only the Commercial Invoice and the Letter of Indemnity issued by Trafigura in favour of Huron. After receiving the payment from negotiating bank, Trafigura authorized the contracting shipowner, Morelia Overseas Inc., to release the cargo to Huron against a letter of indemnity pursuant to charter party.
Huron didn't reimburse the issuing bank for the amount paid under letter of credit and soon after it obtained the cargo went into liquidation. In an attempt to recover its debt from Huron for the amount paid under letter of credit the issuing bank demanded the original shipping documents from the negotiating bank which in its turn referred the demand to Trafigura.
To comply with letter of credit requirements, Trafigura arranged with the ship manager in Singapore to have the original set of Bills of Lading exchanged with a new set of Bills of Lading showing the details required by L/C.
The ship manager agreed to do so provided the original set of Bills of Lading be surrendered for cancellation and the new set of Bills of Lading be claused to indicate that the voyage had been completed. Thus the ship manager representative wrote the words"Voyage accomplished. Null and void" in manuscript on the back of each of the three new Bills of Lading. The ship manager representative retained one of the three new Bills of Lading on behalf of the Master on whose behalf it furnished a receipt for one of the originals.
Trafigura then sent the two original new Bills of Lading and the Master’s receipt for the third original Bill of Lading to Pertamina, who passed the documents in the banking chain for reaching to Kookmin Bank. This did happen. The two new Bills of Lading arrived in the end at Kookmin Bank via London branch of ANZ Bank.
Kookmin Bank sued all parties involved: Trafigura, the shippers of the cargo (Pertamina PT), Morelia Overseas Inc. as contracting owners of the ship Shanghai and the ship managers, Tanker Pacific Management.
Who is to blame for what happened?
Contracting shipowners? In delivering the cargo against Trafigura’s letter of indemnity, they complied with charterer’s voyage instructions.
Ship managers? All what they did was to protect the shipowner against the risk of competing claims for the cargo. That’s why they claused the new set of Bills of Lading with the words: "Voyage accomplished. Null and void".
Trafigura? Trafigura complied with both the terms of sale contract and L/C. They were not concerned with the financing arrangements between Huron and its bank. Trafigura opted to tender the letter of indemnity instead of Bills of Lading due to the discrepancies found in Bills of Lading. The fault was on the part of Kookmin Bank which should have asked that the letter of indemnity for missing bills of lading be made in their favour, not addressed to applicant.
Here is an example of wording that may be used in L/C:
“In the event when the beneficiary is not able to deliver the shipping documents/ full set of Tanker Bills of Lading within 30 banking days from the date of Tanker Bill of Lading, the payment shall be effected against the Commercial Invoice and a letter of indemnity issued by beneficiary in favour of issuing bank, countersigned by the beneficiary’s bank for authentication of beneficiary’s authorized signature, in the following format:
To: ….. (name of issuing bank) ….
We refer to a cargo of …..…………. net US Barrels of Russian Export Blend Crude Oil loaded on board the vessel ……..… at the port of .......... pursuant to Bill of Lading No. …………. dated …/…/2006, covered by the documentary credit number ………. issued byyourselves on ….. (date)…… Although we have agreed to sell the above mentioned cargo to Messrs.…(name of applicant)...…, we have been unable to provide you with the full set of original 3/3 Original “Clean on Board” Bills of Lading and the other original shipping documents requested by documentary credit number ……….. covering the said sale.
In consideration of your undertaking to pay to us the full purchase price of USD ………………. of the above mentioned cargo with value … latest 30th day after Bill of Lading date ….. , we hereby expressly warrant that we have marketable title to such crude oil cargo and that we have the full right and authority to transfer such title and to effect delivery of the said crude oil cargo to you.
We further agree to make all reasonable efforts to obtain and surrender to you/ ….. Bank (issuing bank) for account of Messrs ….. (name of applicant), as soon as possible, the full set of original Bills of Lading and other shipping documents as requested by documentary credit referred to above and to protect, indemnify and hold you harmless from and against any and all damages, costs and expenses (including reasonable legal fees) which you may suffer or incur by reason of the original Bills of Lading and other shipping documents remaining outstanding, including, but not limited to, any claims or demands which may be made by a holder or transferee of the original Bills of Lading or by any other third party claiming an interest in or lien on the cargo or proceeds thereof.
This Letter of Indemnity shall be governed by and construed in accordance with the English Law and any disputes hereunder that cannot be settled by mutual agreement between the parties shall be subject to the exclusive jurisdiction of the English Courts.
This Letter of Indemnity shall expire 14 months after the Bill of Lading date or upon our tender of the full set of original Bills of Lading and other shipping documents to you/ …. Bank, in strict conformity with the terms and conditions of their documentary credit number ……, whichever occurs first.
For and behalf of ......name of seller...........................................
By: ................................... Name and Title
The case of Trafigura Beheer BV vs. Kookmin Bank Co (2006) EWHC 1450 raised a number of issues:
Letter of Indemnity provided by Trafigura to Huron stated that the two Bills of Lading and Master’s receipt be sent not to issuing bank but to L/C applicant, Huron. There was no provision in the letter of indemnity provided by Trafigura to Huron that issuing bank receive any Bills of Lading at all, so the issuing bank had no legal basis to ask for the original set of Bills of Lading after making the payment against the invoice and a letter of indemnity addressed to Huron.
In order to have been entitled to original set of Bills of Lading required in L/C, Kookmin Bank should have asked that the letter of indemnity for missing bills of lading be made in their favour not addressed to applicant.
Only then issuing bank may sue the beneficiary for failure to submit the Bills of Lading.
English Court interpretation was that L/C option to pay against invoice and letter of indemnity for missing Bills of Lading is intended not just for the situation when conforming documents are not available but also when the documents are available but do not conform with L/C terms.
Here is what Court said on this matter:
“The argument raised by Kookmin to the effect that the provision is inapplicable where Trafigura had available to it Bills of Lading which were non-compliant is to be rejected out of hand. It follows that, contrary to Kookmin's submissions, the presentation of the LOI cannot in itself constitute a representation that Trafigura did not have any Bills of Lading available to it. At most it could constitute a representation that it did not have conforming documents available to it which, it is common ground, was true.”
Huron? Huron manipulated Kookmin Bank from the beginning. It should have alarmed Kookmin Bank that the terms of purchase contract required to be financed provided that “Bills of Lading be issued or endorsed to the order of buyer” and that the letter of indemnity was addressed to Huron.
But if there is someone to blame for Kookmin Bank’s loss then it should be searched at Kookmin Bank itself as the bank’s employees fail to make proper security arrangements.
Here is what Court said on this matter:
“The sale contract provided for property to pass to the Buyer at the ship's flange at the load port and at the time when discharge instructions and delivery to Huron took place, the shipping documents were still in the control of the shippers who were entitled to change their delivery instructions to the shipowners. No conversion could take place at either point because Kookmin had no entitlement to the cargo, no entitlement to any B/L and no interest in the cargo. Kookmin had agreed to pay against the LOI. Once payment was made under the L/C on presentation of the LOI, there could not be any issue as to who was entitled to the cargo, as between Trafigura and Huron and the ship owners were entitled to deliver the cargo to Huron on Trafigura's and Pertamina'sinstructions.
It is Kookmin's misfortune that it failed to make appropriate arrangements which gave it a contractual right against the carriers or some form of security against its customer in respect of reimbursement of the sum which it had paid under the L/C, whether by requiring the LOI to provide for delivery of original B/Ls to it, rather than its customer or by some other means.”