Recourse in case the documents are discrepant or forged

A member of letterofcreditforum.com raised on the same forum a question regarding  the right to recourse in case the documents honoured or negotiated are found to be discrepant or forged and rejected by the issuing bank or applicant. The question is not new. Still, it has remained to be one of the focuses of attention of LC practitioners in the world.  As a banker, I wish to share my view on the question as follows:

What is recourse?

In the context of documentary credit operations, recourse is normally understood as the nominated bank’s right to recover from the beneficiary any payment or advance that the nominated bank has made to the beneficiary in the event reimbursement is not received from the issuing bank. That such a recourse is available or not depends on the agreement between the nominated bank and the beneficiary and/or the rules of UCP, i.e.  the payment or advance has been made on a with or without recourse basis.

Recourse in case the documents are discrepant and rejected by the issuing bank

Unless a nominated bank is the confirming bank, an authorization to honour or negotiate does not impose any obligation on that nominated bank to honour or negotiate, except when expressly agreed to by that nominated bank and so communicated to the beneficiary (Art 12 (a) UCP 600). 

In the light of the above provision, a nominated non-confirming has its own option to honour or negotiate the documents either with recourse or without recourse. If a nominated non-confirming bank has agreed with the beneficiary to honour or negotiate the documents with recourse and if reimbursement is not received due to a correct refusal by the issuing bank, that nominated bank will have recourse to the beneficiary. However, the nominated bank will bear the risk of loss, i.e. not having recourse to the beneficiary, if it has agreed to honour or negotiate the documents without recourse.

A nominated confirming bank must honour or negotiate the documents without recourse if the credit is available with the confirming bank (UCP 600 Art. 8).  In view of this provision, a confirming bank will not have recourse to the beneficiary once the documents honoured or negotiated by the nominated confirming bank are found to contain discrepancies and rejected by the issuing bank. However, in the scenario where the documents presented are found by the confirming bank to contain discrepancies and the confirming bank has agreed with the beneficiary to honour or negotiate under reserve, i.e. on a with recourse basis, that confirming bank will have recourse to the beneficiary if reimbursement is not received due to a correct refusal by the issuing bank.

Recourse in case of fraud

The famous court case between Banco Santander and Banque Paribas led to some changes in UCP regarding the position of the nominated bank in case of fraud.  These changes are reflected in the following provisions:

UCP 600 Article 34 says: A bank assumes no liability or responsibility for the form, sufficiency, accuracy, genuineness, falsification or legal effect of any document …

UCP 600 Sub-article 12(b) says: By nominating a bank to accept a draft or incur a deferred payment undertaking, an issuing bank authorizes that nominated bank to prepay or purchase a draft accepted or a deferred payment undertaking incurred by that nominated bank.

UCP 600 Sub-article 7(c) says: An issuing bank undertakes to reimburse a nominated bank that has honoured or negotiated a complying presentation and forwarded the documents to the issuing bank. Reimbursement for the amount of a complying presentation under a credit available by acceptance or deferred payment is due at maturity, whether or not the nominated bank prepaid or purchased before maturity. An issuing bank's undertaking to reimburse a nominated bank is independent of the issuing bank’s undertaking to the beneficiary.

Under these new and/or revised provisions, the nominated bank that has acted on its nomination is entitled to full reimbursement from the issuing bank even in case the documents honoured or negotiated are found by the issuing bank to be forged. Of course, the nominated bank must evidence that it has honoured or negotiated the documents without recourse and it has checked the documents with reasonable care and has not been aware of any sign of fraud.

My above explanation about the position of the nominated bank in fraud cases is mainly based on the new provisions of UCP. However, I wish to share Mr. T.O Lee’s concern in his response to my query that these new provisions may not be workable in the courts of law globally.

Let’s take China as an example. The Supreme People’s Court promulgated The Regulations of The Supreme People’s Court on Several Issues in the Hearing of Cases Involving Disputes over Letters of Credit (entered into effect on 1st January 2006). According to these regulations, the Chinese courts will not support a credit dispute regarding the underlying transaction between the applicant and the beneficiary of the credit, except in the case of fraud. According to Jia Hao’s explanation (in an interview by Kim Christensen of lcviews.com), the provision (Articles 8) reflect the well-established “fraud exception rule” in the letter of credit world. The purpose of such fraud exception rule is to stop fraudsters from getting benefits by use of letters of credit.

Regarding fraud exception rule, UCC Article 5 of the United States also provides that a court may enjoin honour of a payment demand when a required document presented under the letter of credit is forged or fraudulent or where there is fraud in the transaction.

It is largely understood that local law always prevails over rules including UCP rules. In reality there is a practice that has been globally recognized: where fraud is involved, the court is normally on the side of the defrauded. Suppose that the issuing bank is obligated under UCP to reimburse the nominated bank,  the issuing bank will normally ask the applicant to deposit funds (in case the import transaction is self-financed) or to provide signed promissory note to the issuing bank (in case the import transaction is financed by the issuing) to cover the payment. Thus, the issuing bank’s risk is passed to the applicant. However, except where there is a collusion between the applicant and the beneficiary like Solo Industries fraud case, no applicant easily agrees to pay for the fraudulent documents. Most of the time the applicant (maybe with the issuing bank’s consultancy) will seek an order from the court to suspend the payment. And it is quite common that local courts seem to be ready to issue such an order to protect the interest of the applicant. Such an order will become much more forceful especially when the nominated bank has honoured or negotiated the documents with recourse. There is a bad habit in letter of credit operations that where there is the court’s interference some nominated banks often claim they have honoured or negotiated the documents without recourse while in fact they have done with recourse.

China’s above-mentioned regulations has no clear provisions on how the court should deal with fraud cases where the nominated bank has honoured or negotiated the documents without recourse, neither does the United States’ UCC Article 5. So far, it is too early to know how the courts of law globally will deal with these cases. Perhaps we had better take a wait and see attitude towards the matter.

Pending the future responses from the courts of law to the related provisions in UCP 600, sharing the view of a member on letterofcreditforum.com, I think in fraud cases the nominated bank should in the first place take legal action against the beneficiary to get back the money if no reimbursement is received from the issuing bank. It is more convenient and advantageous for the nominated bank to have recourse to the beneficiary as the nominated bank and the beneficiary are normally in the same country. And of course, I believe no court supports the party who has committed a crime.