Is Bill of Exchange an Indispensable Payment Instrument?

Introduction

What comes to my mind is Late Mr. Bernard Wheble’s reply on the usage of drafts in LC transactions. He was an authority on ICC payment publications like UCP and URC. He was also holding the Banking Technical Committee Chair of ICC Paris for a long time. Some of us in Trade used to see him in Sri Lanka after almost every revision of UCP at seminars organized by ICCSL Colombo. Later on, I also had an opportunity of serving in the executive committee of ICCSL and was fortunate to meet him personally and interact with regard to various issues regarding letters of credit and collections. In one of those interactive discussions, I inquired him about the likelihood of removing drafts one day from the requirement of LC available by negotiation. His reply was ‘why should we (ICC) move away from a tradition that has done no harm to negotiability under LC operation’. He called this ‘inertia of tradition’. To this date a number of times different working committees have raised the same question and some of the committees even have gone to the extent of requesting ICC to revise UCP600 mainly to accommodate removal of drafts altogether from LCs. However, from the recent guidance paper issued by ICC what I understand is that ICC still does not want to advocate removal of drafts but to leave the requirement of draft as an option for the benefit of the segments that want to have it in their LCs. 

Drafts in Relation to Collection

Collection rules may be the least revised rules by ICC. The current Uniform Rules for Collection (URC) revision (522) was approved in May 1995 and came into effect from 1 January 1996. The previous ICC publication 322 on URC was published as far back in 1978. The ICC committee involved in this URC revision now in practice was headed by Mr. Lakshman Wickramaratne who was also a well-known Trade Finance Banker heading trade operation at former Mercantile Bank in Sri Lanka which was later acquired by Hatton National Bank.

The definition of collection as per URC 522 article 2 is ‘Handling of documents by banks, in accordance of instructions received in order to

i)                Obtain payment and/or acceptance or

ii)               Deliver documents against payment and/or against acceptance or

iii)             Deliver documents on other terms and conditions

In terms URC article 2 Documents may include either financial documents such as Bills of Exchange, Promissory Notes, cheques or other similar financial instruments with commercial documents such as invoices, transport documents or any other document called for in the underlying commercial contract. Banks generally deals with documentary collection. By definition, documentary collection may or may not be accompanied by financial documents. What does this mean? URC 522 does not categorically state that Bill of exchange is a ‘Must’ for a documentary collection provided ‘non submission’ of Bill of Exchange is not contrary to the provision of a national state or local law and/or regulation which cannot be departed from. Therefore, as far as the documentary collections are concerned, one can say safely that bill of exchange is not an indispensable payment instrument. Having said that, what comes to our mind next is; can the banks safely take up all collections without bills of exchange and provide post shipment financing like bill discounting/purchasing or forfaiting relying on commercial documents alone as valuable collaterals. Under a normal circumstance when handling collection what bank does is; to follow the instructions of the collection letter given by the principal (seller). The same instructions are conveyed by the remitting bank (seller’s bank) to the collecting bank (buyer’s bank). What the remitting bank literally does is ‘a job of a post office’. In a normal collection neither the remitting bank nor does the seller receive an assurance of the buyer’s bank that the payment shall be made. In the absence of assurance from the banks under a collection subject to URC, the seller or the remitting bank that discounted or purchased a documentary collection has to seek redress under the prevailing legal framework. In a such scenario the availability of bill of exchange duly presented might help the bank to proceed with recovery action against the presented but unpaid bill as the holder in due course under the Bills of Exchange Act and the seller as the affected party under the sales contract outside URC subject to law of state. If an accepted bill is unpaid on maturity, it shall be construed as a default by the buyer after acknowledging of his indebtedness. Hence the seller has recourse to the buyer for recovery against the dishonoured bill and the bank that discounted the documentary collection accompanied by bill of exchange has recourse to the seller (Drawer) as the Bona-fide holder of the bill. In that sense a correctly worded and duly presented bill of exchange under a collection shall yet be considered an indispensable payment instrument especially in international trade transactions. No replacement for this valuable payment instrument has yet been found although several alternate methods have been suggested to safeguard its security aspect. However I believe it is a pressing need to find a reliable and a less complex payment instrument at this digital stage.

Draft in relation to LC transaction

The appointed Committee of the Banking Commission Headed by Mr. David Meynell suggested that more comprehensive guidance should be provided on the use of drafts under Letters of credit and accordingly a comprehensive guidance paper was issued by ICC Paris in January 2019 on use of drafts for LC transactions.

As per the feedback and the study carried out by ICC committee, many were of the view that requirement of drafts in Letters of Credit transactions did not provide any benefit and the definition of ‘Honour’ simply provided for payment at sight or deferred payment thus making draft a redundant instrument. However, the Executive Committee was of the view that despite the problem likely to be faced regarding drafts, combined with documentary credits, still have enormous support from certain parts of the world. Hence whether or not drafts are required under Letters of Credit, this is not a UCP issue and exclusion of drafts from the UCP would not stop this practice.

The guidance paper further stated that almost every bank’s application form, whether in paper form or on-line, have a pre-set requirement for the presentation of a draft. Whether a draft is required or not is within the hands of every issuing bank and does not need a change to the UCP to achieve it. Merely deleting drafts from UCP will not stop their usage. This view was substantiated with statistical data provided by SWIFT to the Global Survey conducted by ICC in 2018 according to which 73.2% of credits issued by MT700 were available by negotiation in 2017 which potentially have been accompanied by drafts whilst 7.9% were available by acceptance for which obviously would have been against drafts.

In the light of the above, the Executive Committee recommends that “UCP’s unique characteristic of global acceptance is maintained and suggestions for non-optional changes that only benefit particular business or geographic segments of the user base are opposed. Guidance, not deletion, is the appropriate response to the issue of drafts under documentary credit transactions.” In arriving at this consensus ICC Executive Committee has obtained opinion of ten working committees from different regions of the globe on a set of identical questions on the subject and based on which the committee has prepared the guidelines.

It is clear that the practice of requiring drafts under documentary credits was more commonplace in the past. One such example cited in the guidelines - the Colombia Law Review (Volume No4 of April 1922) containing a chapter on Documentary Letters of Credit, in which frequent reference is made to a letter of credit authorising the drawing of drafts on the issuing bank and undertaking that drafts so drawn would be honoured. At that time, all documentary credits were calling for draft and it was advised an appropriate clause be included in Letters of Credit irrevocably undertaking to pay within the terms and conditions of the credit. Extension of such practice were continued until recently. The first version of the UCP published in 1933 stated in Article 9: ‘When an irrevocable credit is opened in the form of a Commercial Letter of Credit, the Letter of Credit itself must include notification of the opening of an irrevocable credit and constitute the definite engagement by the issuing and holder in good faith to honour all drafts issued by virtue of and in conformity with the clauses and conditions contained in the document.’ Bank towards the beneficiary

However, the strict requirement of calling for a draft began to disappear from 1951 revision (ICC Publication151) as you will observe from its article 5 as follows:

“Irrevocable credits are definite undertakings by an Issuing Bank and constitute the engagement of that Bank to the beneficiary or as the case may be, to the beneficiary and bona fide holders of drafts drawn thereunder that the provisions for payment, acceptance or negotiation contained in the credit, will be duly fulfilled provided that the documents or as the case may be, the documents and the drafts drawn thereunder comply with the terms and conditions of the credit.”

In 1951 for the first time ICC accepted that Draft is not mandatory by specifically wording in the article ‘as the case may be’. This wording continued into UCPDC 222 published in 1962 as a revision to ICC publication 151. In 1974 this position was slightly changed with the publication 290 bringing more clarity to the requirement of draft in a LC transaction as follows:

Article 3: a) An irrevocable credit constitutes a definite undertaking of the issuing bank, provided that the terms and conditions of the credit are complied with:

i      to pay, or that payment will be made, if the credit provides for payment, whether against a draft or not;

ii       to accept drafts if the credit provides for acceptance by the issuing bank or to be responsible for their acceptance and payment at maturity if the credit provides for the acceptance of drafts drawn on the applicant for the credit or any other drawee specified in the credit;

iii   to purchase/negotiate, without recourse to drawers and/or bona fide holders, drafts drawn by the beneficiary, at sight or at a tenor, on the applicant for the credit or on any other drawee specified in the credit, or to provide for purchase/negotiation by another bank, if the credit provides for purchase/negotiation.

From the above you will observe a Clear differentiation had been created in UCP290 stating that payment could be made with or without drafts in the case of LCs available by payment. However, the drafts have to be presented, if they were to be accepted/paid against LCs (available) by acceptance or purchased / negotiation. Different schools of thought including ICC guidance paper express a view that UCP 290 made a sweeping change in allowing payment, acceptance and purchase/negotiation without a draft. This is not so. I am not quite agreeable to this view. This was neither the understanding that the documentary examiners had at that time nor had it been explicitly maintained by ICC. To the best of my knowledge ICC did not subscribe in the past to the view expressed in the recent guidance paper. Anyone reading through the lines of the said article will be able to understand clearly that UCP drafters had specifically wanted drafts to be presented for LCs available by purchase or negotiation and acceptance. UCP290 categorically stated ‘to pay or payment will be made if the credit provides for payment whether against a draft or not’, This needs to be understood in the light of LC customs and practices at that time. In the article 3 of UCP290, the wording ‘to pay or that payment will be made’ has to be understood only in the context of LCs available by payment with or without drafts. Against a LC available by payment an issuing bank might elect to pay immediately with available same day funds or pay after notifying with value two or three days. In which case both would be construed as a valid payment under a LC. One has to bear in mind that up to UCP400 the issuing banks were making passive undertaking under letters of credit. The reason was that majority of drafts called for under the letters of credit were drawn on applicants and the issuing bank’s assurance was to see that such draft would be accepted on presentation and paid on maturity. In the case of LCs on sight payment, the issuing bank’s commitment was to pay or ensure payment whether a draft is presented or not. Non requirement of drafts for ‘payment LCs’ was clearly established in my view as per UCP290 but requirement of drafts for LCs on acceptance and negotiation remained unaltered.  Accordingly, the draft remained part and parcel of the LC transactions despite the options made available to the applicants and issuing banks under the provisions of UCP 290 article 3 to pay with or without drafts.

Although draft became an optional requirement in respect of sight payments under LCs, my understanding is that ICC did not want to discard the requirement of drafts under LC transactions. As such UCP publication 400 that came as a revision to UCP290 did not make much significant change to the hitherto accepted practice with regard to requirement of drafts. Nevertheless UCP 400 introduced another payment mechanism that helped to do away with the requirement of drafts whilst accommodating payment at maturity. This was LCs on ‘deferred payment terms’ that provided either nominated or issuing bank to undertake payment on a future date. This was a welcome move to those who have been waiting to transact strictly based on LC terms without resorting to legal action against bills of exchange act. UCP500 that came as a revision to UCP400 went further allowing negotiation specifically with or without drafts but I cannot say; based on the article 9 that ICC made any provision for acceptance credit to accept documents without drafts. However, the guidance paper referring to ICC publication namely ‘Standard Documentary Forms for UCP500’ expressed that by unmarking the relevant Box in the LC application, a bank could be instructed to allow acceptance without calling for a draft. In my opinion such a contention is untenable and does not reflect the real meaning of the article 9 of UCP500. Nevertheless, it has to be appreciated that UCP500 by disallowing drafts to be drawn on applicants and making it mandatory to issue on issuing bank or confirming bank made a sweeping change to the irrevocable undertaking of the issuing bank. From here onwards the passive undertaking of the issuing banks that usually stated ‘will be paid or will be honoured……’ in Letters of Credit began to reflect a direct undertaking like ‘will pay or accept…’ to the beneficiary. In that sense I believe the need for drafts in Letters of Credit as the second option to have recourse to applicant in the event of non-payment outside Letters of credit became redundant. The reason for that is, under a documentary credit an issuing bank is primarily liable for payment and not the applicant. UCP500 also made another important change by providing an option for negotiation with or without draft. Despite the important changes made to UCP over a period of time with regard to the requirement of drafts in Letters of Credit transaction, the unique concepts associated with bills of exchange such a negotiation, discounting and the privileges enjoyed by holder in due course with legal protection appeared to have made difficult for trading community to totally disregard drafts in international transactions. Hence although the usage of drafts has considerably reduced and the mindset of the trading community has shifted to a certain extent from security to speed of the transaction, we still find drafts are significantly in use; for Letters of Credit transactions in many parts of the world.

It is pertinent to mention that even verdicts given in certain landmarked cases where drafts were not involved, the judges have applied law relating to bills of exchange to justify their decisions. One such case was Banco Santander Vs Banque Paribas (2000) where a deferred payment bill under a Letter of Credit undertaken to pay on maturity by the confirming bank was contested on the ground of prepayment by the confirming bank before maturity. Apart from the issues with regard to interpretation of relevant article in UCP500 it was argued whether the drawee that confirmed the credit was able to discount its own undertaking before maturity under the immunity against ‘unknown frauds’ available to the holder in due course. This issue came up after detecting a fraud in the presented documents before the maturity.

This irregularity was promptly addressed in UCP 600 that came into effect on 1st July 2007 by stating that the nomination of a bank included authorising a bank to prepay or purchase (included in Article 7 Issuing Bank Undertaking and Article 8 Confirming Bank Undertaking). UCP 600 Article 12 further stated that by nominating a bank to accept a draft or incur a deferred payment undertaking, an issuing bank authorises that nominated bank to prepay or purchase a draft accepted or a deferred payment undertaking incurred by that nominated bank prior to maturity date. Looking at the timely changes made by ICC in UCP600 to avert likely situations described in the preceding paragraph and also the introduction of article 2 defining ‘ honour and negotiation’ which provided a different meaning to that of ‘honour and negotiation associated with drafts, some feel that drafts have become redundant under Letters of Credit Transaction. 

Conclusion

However, I too subscribe to the view expressed by ICC that removing of drafts from UCP itself does not remedy the issue. Firstly, banks should relook at their LC applications and make necessary adjustments in the application with regard to the requirement of drafts. Customer education with regard to the implication of using drafts is another important matter that should be looked into as the second step by the respective issuing banks. Having said this, I would like to leave to your good judgement whether we are at this digital stage in a position to consider Bill of Exchange is still a redundant document. It should be borne in mind that we have not yet found a legally valid and globally recognized payment instrument as secure as Bill of Exchange that can be used in a transaction where acceptance is needed whether it is under LC or on Collection.