What bankers should know about the substitution of shipping documents in back-to-back L/Cs

Reading about the reluctance of some bankers to get involved in substitution of shipping documents under back-to-back L/Cs I thought that the following notes would help them to get a better understanding of these matters.

Substitution of shipping documents covering container shipments

If the middleman wishes to conceal the identity of his supplier to the ultimate buyer, he can instruct his supplier to apply neutral marking on the packages so as to prevent disclosure of its identification mark (supplier's name, address or marks of factory) and purchase order number, or alternatively, to apply the shipping marks on adhesive labels to allow the middleman to remove them later and apply its own shipping marks.

For this purpose the middleman may include in the purchase contract or purchase order the following condition:

"No name, address or marks of factory shall appear on the goods, boxes, cartons and any packagings."

An alternative is to use the services of the freight forwarder for this activity.

Here is what the General Conditions (2005) of the Swiss Freight Forwarding and Logistics Association (SPEDLOGSWISS) provide in Article 10 (Origin Marks):

"If the true destination of the goods is not to be known to the consignor, or their origin to the consignee, the forwarder must be informed of this in writing.

If the consignee instructs the forwarder to send the shipment on to a third party, the forwarder shall not, even in the absence of special instructions, make known to the third party the name of the original consignor and the origin of the goods. The forwarder shall remove the origin marks only if requested to do so in writing."

One possibility for the middleman would be to buy on FOB terms from supplier but there is a disadvantage. About a year ago, I was confronted with a situation where the freight forwarder hired by FOB buyer declined to issue the booking confirmation to the shipper (FOB seller) and declined to revealed the reason for doing this. At this point I must say that in FOB deliveries it is the obligation of seller to book the freight space with the container shipping line/ or freight forwarder nominated by the buyer. At the insistence of shipper, the forwarder revealed that FOB buyer arranged with forwarder to switch the set of Bills of Lading issued to shipper with a new set of Bills of Lading indicating the FOB buyer as shipper and a different destination. What the FOB buyer was doing was to buy at a lower price offered by supplier thinking that it sells to a country with high import tariffs and re-sale to a buyer located in a country with lower import tariffs. The deal involved regular FOB shipments of goods in containers and the payment was by L/C. As my relationship was with the supplier I don’t know if the L/C in question was a back-to-back L/C, I can only guess considering the information received at that time. The point is that whatever opportunity may be there for re-sale if the middleman intends to have a long term relationship with the supplier there is a risk that the latter may find out about the arrangement of middleman with the carrier for the switching of Bills of Lading and not make further deliveries. It shouldn’t be any problem in the re-sale of agricultural commodities but for a manufacturer that wishes to build a brand value abroad this kind of re-sales may compromise him. 

For middleman an alternative to FOB purchases would be to buy on FCA terms on presentation of FCR document indicating the bank issuing the back to back L/C as consignee. The bank pays or assumes the payment undertaking to the supplier and then arranges with the carrier/ forwarder to release the FCR document in exchange for Bills of Lading required under Master L/C. 

Substitution of shipping documents covering bulk commodity shipments

The reasons why the substitution of B/Ls is required in commodity trade differ in function of the commodity in question.

In oil trade, the substitution of B/Ls is necessary when the middleman buys FOB from his supplier(s) parcels of oil cargoes with different specifications for re-sale as homogeneous cargo on CFR/ or CIF terms. Provided the vessel is technically capable to commingle the cargoes on board and the shipowner consents, before the beginning of blending operation the middleman is required to surrender to shipowner’s representative at port of loading all the original B/Ls issued for the unblended cargo for cancellation and at the completion of blending operation, shipowner’s representative will provide in exchange a new set of B/Ls reflecting the actual grade that has been blended. Bankers dealing with such B/Ls should obtain a written confirmation from shipowner that cargo description made in switched B/Ls is accurate.

In the trade with vegetable oils (soybean oil and palm oil) substitution of B/Ls is required by middleman that buys “en gross” and sells “en detail” by splitting up the bulk cargo shipped under one set of B/Ls into smaller parcels for re-sale to multiple buyers. Bankers dealing with such B/Ls should check whether the sum of quantities of cargo parcels stated in switched B/Ls is equal to the cargo quantity stated in original set of B/Ls issued for the bulk cargo.

1. Bankers risk in paying against switched Bills of Lading for bulk commodities

A trading company acting as middleman in back-to-back sales can conceal the identity of its supplier(s) to end-buyer(s) (and vice versa) by arranging with the carrier to substitute the supplier B/Ls with B/Ls showing middleman as shipper. Other changes include the name of notify party, freight notations and sometimes the port of discharge.

In commodity trades, the typical scenario where substitution of B/Ls is required arises when a middleman buys FOB and then sells CFR/or CIF to end-buyer. For this purpose the middleman charters a ship under a voyage charter party in which he agrees with the shipowner the conditions for substitution of B/Ls. So far so good but where a bank finances a deal as it usually happens care must be taken to not allow the middleman commit a fraud. Among the things that a banker asked to finance the purchase of a bulk commodity should do it is to require the middleman that fixing of vessel be made subject to bank’s approval and regardless of whether the payment of supplier is required to be made by L/C, checks on shipowner and its port agents[1] should also be made. 

Most frauds committed so far with switched B/Ls involved the cooperation of either the shipowner or port agent of vessel. If the financing bank accepts them as reliable, then it should arrange the substitution of B/Ls directly with them without letting the middleman to take the B/Ls not even under trust receipt.

I chose three case studies based on legal disputes decided in Singapore concerning the fraudulent use of switched B/Ls. One of these cases is BNP Paribas v. Bandung Shipping Pte Ltd. [2003]. Here is the story:

The middleman asked BNP Paribas to finance several purchases of palm oil from Malaysia and Indonesia for re-sale through its parent company to Indian retailers.    

The middleman bought “en gross” to re-sale “en detail”. Hence, substitution of B/Ls was not required solely to conceal the identity of suppliers but also to allow the re-sale of smaller parcels of bulk cargo to multiple buyers, by splitting up the quantity in original B/Ls in smaller parcels covered by distinct B/Ls.

The dispute in Court concerned a cargo of 10,000 metric tonnes of crude palm oil which was initially carried from Rotterdam to Batam (Indonesia) by one carrier and then from Batam (Indonesia) to Kandla (India) by another carrier. BNP Paribas received through banking channel and held the original set of B/Ls made out to order of supplier, which covered the sea carriage from Rotterdam to Batam (Indonesia).

The first carrier discharged the cargo at Batam (Indonesia) against letter of indemnity as per charter party terms. Without the knowledge of BNP Paribas, the middleman re-loaded part of said cargo, 7,517.599 metric tonnes, on board of a vessel belonging to a different shipowner for carriage to Kandla (India). The cargo was split in 24 parcels of 250 metric tonnes each[2] and for each parcel was issued a B/L made out to order of middleman, indicating the middleman’s parent company as notify party.   

At Kandla, the cargo was discharged against a letter of indemnity from middleman’s parent company. After three weeks from the date of discharge at Kandla, the bankers from BNP Paribas found out what happened with the pledged cargo. That was possible because while the original B/Ls sent by BNP Paribas to an Indian bank for sight collection remain unpaid, the middleman held the switched B/Ls issued by the second carrier to its order. Although BNP Paribas obtained the switched B/Ls from middleman, by this time it was already too late. Bankers from BNP Paribas should have been concerned that although the cargo was to be sold inIndia, the original set of B/Ls covered only the carriage from Rotterdam to Batam (Indonesia).

As the middleman’s parent company did not pay, BNP Paribas recalled the original set of B/Ls, thus holding both original B/Ls and switched B/Ls. Then it sought to recover the amount of loss from the second carrier, Bandung Shipping. Middleman cheated both the financing bank and the second carrier, as there was no way for the latter to know that cargo is pledged to the bank. Perhaps, should the bank have been made proper inquiries, the fraud was avoidable. 

The second case study is based on the case of UCO Bank v. Golden Shore Transportation Pte Ltd. [2005]. The middleman asked UCO Bank to finance the purchase of four shipments of Sarawak round logs by issuance of L/Cs in favour of the four suppliers.

For each shipment was issued a set of B/Ls indicating the respective supplier as shipper. All the B/Ls were made out to order of UCO Bank (L/C issuing bank) and as notify party were indicated both the middleman and UCO Bank.

Without the knowledge of UCO Bank the middleman arranged with the shipowner to issue switched B/Ls for each of the four shipments indicating the middleman as shipper and made out to its order. Faulty shipowner did not retrieve the original B/Ls before issuing the switched B/Ls. The middleman promised to shipowner that it would obtain and surrender the original B/Ls later and as security, gave the shipowner a letter of indemnity. While the original B/Ls were at UCO Bank, the middleman endorsed the switched B/Ls to various buyers which then obtained the cargo from shipowner.  

The third case study is based on the case of Samsung Corporation v. Devon Industries Sdn Bhd [1996] and is similar to the previous in that carrier did not retrieve the original B/Ls before issuing the switched B/Ls. The middleman bought a number of parcels of soybean oil from different shippers for re-sale. The middleman agreed with end-buyer that payment be made against switched B/Ls indicating middleman as shipper. Although the middleman get the payment from end-buyer, he didn’t pay one of his suppliers who held the original B/Ls. Court found that fraud was possible thanks to the cooperation of vessel’s port agent.

2. Payment against Mate’s Receipt

Aside of the practice of switching of B/Ls, there is also a practice in charter shipping to pay the FOB supplier against the Mate’s Receipt showing the middleman as consignee and notify party. The middleman makes the necessary payment arrangements with the FOB supplier to obtain the Mate’s Receipt and then surrenders the document to the vessel’s port agent in exchange for the issuance by the latter of B/Ls indicating the middleman as shipper and actual receivers as notify party.

It is also possible to arrange a replacement of Mate’s Receipt with B/L under a back-to-back L/C taking into considerations the same precautions as in the case of switching of B/Ls. The Mate’s Receipt given by carrier to FOB supplier may indicate either the middleman or the bank issuing the back-to-back L/C as consignee and notify party.

I have seen in voyage charter parties for the carriage of semi-finished steel products, steel scrap and vegetable oils, charterer’s clauses requesting the shipowner that Master issue the Mate’s Receipt showing charterer as consignee and notify party and that shipowner issue latter B/Ls showing middleman as shipper and end-buyer as consignee and/or notify party. I can understand that shipowners are willing to do this to avoid the trouble with switching of B/Ls and that middleman do this to conceal the origin and destination of cargo. However, naming of bank as consignee in Mate’s Receipt (as I have seen once in a L/C SWIFT Message) doesn’t offer the same security as B/Ls made out to order, since Mate’s Receipt is not a document of title to the goods but only a proof of loading on board. The Mate’s Receipt is a document wherein the Master or the deck officer confirms the loading of cargo on board the vessel on the basis (in case of steel products shipped as break bulk cargo) of the tally of goods made by vessel’s representative along with port’s representative. Perhaps, one way around would be that bank issuing the back-to-back L/C to obtain shipowner’s written undertaking that will release the cargo in accordance with bank’s instructions and will keep informed the bank about the arrival of cargo at destination.