What Are the Beneficiary’s Alternatives?
3.28 The harsh truth seems to be that nothing can be done for a beneficiary who is advised of a letter of credit with soft clauses, except to counsel it, as ISBP does, to demand amendments or refuse to accept the credit as a valid discharge of the applicant's payment obligation.
This presupposes, of course, that beneficiaries are sufficiently sophisticated to be able to identify soft clauses, or sufficiently wary to seek advice about the provisions of a letter of credit of which they have been advised. There is a considerable academic literature in China devoted to the pitfalls of soft clauses and means of avoiding them, which seems to be premised on the idea that Chinese beneficiaries are prone to exploitation by unscrupulous foreign applicants.[305] If identifying or objecting to soft clauses is a problem in practice, what are the alternatives for a wary or well-informed exporter, short of insisting on deletion of the soft clause? Because the alternative payment mechanisms are fairly well-known, and because some are covered in more detail in other chapters of this book, I will outline them only briefly here, focusing on those situations where the party who would be the applicant under a letter of credit (eg the buyer under a sale of goods contract) would have a legitimate reason for wanting a soft clause. For the sake of convenience, the subsections that follow use the common example of payment instruments in international sale of goods contracts, although that is obviously not their only use.A. Documentary Collections and Bills of Exchange/Time Drafts:
Back to the Future?
3.29
The use of documentary collections and bills of exchange (called time drafts in North America) is generally regarded as rather old-fashioned because it does not provide the exporter with any certainty (as a letter of credit does, or should) that it will be paid by a solvent entity if it sends the goods and documents to the importer’s country.
An immediate retort to this objection is that the use of a documentary collection and bill of exchange/time draft is no less secure from the exporter’s point of view than is a letter of credit with a soft clause, which can, as we have seen, lead to the result that payment is easily subverted by the applicant’s refusal to issue the relevant documents. There may, however, be other advantages in returning to this supposedly old-fashioned method of payment as a means of avoiding the pitfalls of soft clauses in letters of credit.3.30
The use of bills of exchange/time drafts saw something of a resurgence in the wake of the decision in Banco Santander SA v Bayfern Ltd,[306] where the English Court of Appeal held that deferred payment letters of credit cannot be assigned free of any defect in the transferor’s title, as can bills of exchange, by virtue of the Bills of Exchange Act 1882 (UK), s 38(2), which allows the holder in due course of a bill of exchange to enforce payment under the bill free of any defect of title of prior parties.[307] The resulting chill on the liquidity of the market for discounting deferred payment letters of credit was supposedly remedied by the inclusion in 2007 of art 12(b) of UCP 600, which provides that by nominating a bank to incur a deferred payment undertaking, an issuing bank authorises the nominated bank to prepay or discount the deferred payment undertaking. To the extent that the art 12(b) ‘fix’ works at all, it works only in relation to discounting by the nominated bank, and does nothing to protect the position of third-party forfaiters, at least in countries that have no legislation protecting their position, as does the United States.[308] For that reason alone, bills of exchange/ time drafts may be a more desirable means of payment than deferred payment letters of credit, because they are more readily marketable to third-party forfaiters.
Their attractiveness may be enhanced yet further as they make the transition to electronic form, as considered by Professor Benjamin Geva in a subsequent chapter.[309]3.31
For present purposes, however, perhaps the more significant feature of the use of documentary collections is that the collection instruction describing the documents to be presented in return for payment or acceptance of the bill of exchange/time draft is prepared by the seller/principal and not by the buyer/drawee, pursuant to the Uniform Rules for Collections (1995) (‘URC 522’). If the buyer/drawee has a legitimate reason for making payment contingent upon the production of some document in the buyer’s country, as the buyer did (at least initially) in The Messiniaki Tolmi,[310] it must specifically ask for the document to be included in the list of documents enclosed with the collection, as required by art 4(b)(v) of
URC 522. At the very least, then, the ‘softness’ of the payment obligation must be brought squarely to the seller/principal’s attention. This mechanism would not protect against an unscrupulous refusal by the buyer/drawee to produce the document in question—perhaps nothing can do that—but it would at least avoid one of the problems that apparently exists with soft clauses in letters of credit, namely that the seller/beneficiary is unaware of the ‘softness’ of the obligation undertaken by the issuing or confirming bank.
B. Open Account/Standby Letter of Credit: Not Really the Future at All?
name=bookmark618>3.32 Although letters of credit supposedly provide the seller/beneficiary with security that it will be paid by a solvent party if it sends the goods to the other side of the world, that security comes at a price: banks typically charge about 1% of the face value of the credit as their fee, or possibly more, depending on the applicant’s country. For repeat business, fees of this size can accumulate to a commercially unacceptable level if they must be paid on every single shipment of goods.
For that reason, contracting parties who have some degree of trust and confidence in one another, and/or some reliable information about each other’s creditworthiness, tend to prefer to trade on an open account basis, under which the exporter sends goods to the importer without any guarantee of payment for each particular shipment, but with the importer’s contractual obligation to pay for the goods secured by a standby letter of credit on which the exporter can draw in the event of non-payment by the importer. Open account may even be offered to new customers by an exporter trying to break into a new or competitive market by offering attractive payment terms, although in such a case the exporter’s collateral security (often a stand-by letter of credit) takes on extra significance.3.33 Nothing about this mechanism for payment is new or forward-looking, but it does at least avoid the problems of soft clauses in letters of credit, because the seller/beneficiary’s right to payment is not dependent on presentation of any commercial documents such as bills of lading, packing lists, or the kinds of certificate of receipt called for by soft clauses. The seller/beneficiary presents no commercial documents of any kind; it need only present a beneficiary’s certificate in the event of non-payment, and so is not at the mercy of the requirements of any soft clauses or uncooperative actions by an unscrupulous buyer trying to take advantage of a change in market price. Of course, parties who have no pre-existing trading relationship of trust and confidence may be reluctant to contract on open account terms from the beginning of their relationship, but it is clearly better from the seller/ beneficiary’s point of view than a commercial letter of credit with soft clauses.
C. Blockchain: The Real Future?
3.34 In chapter 12 of this volume, Professor Jane Winn expresses some scepticism about whether blockchain technology will actually deliver on the expectations people presently have for its transformative potential.[311] A thorough examination of the ways in which blockchain technology might possibly transform trade finance in the future is well beyond the scope of this chapter.
For present purposes, it suffices to say that the promise of blockchain is that it will finally replace the use of paper documents in trade finance transactions, a result that has been an apparently impossible desideratum throughout the previous thirty years or so in which electronic communications have been the norm in other aspects of business and daily life. More than $4 trillion in goods are shipped each year, and the cost of required trade documentation is estimated to be as much as 20% of the physical transportation costs; blockchain technology may be able vastly to reduce that number, leading to a significant increase in global trade.[312] With blockchain, there will be no need for the production of any soft-clause- type document such as a signed certificate of receipt or countersigned certificate of inspection, because no part of the transaction will depend on the production of paper documents. Of course, the unscrupulous buyer who wants to take advantage of favourable market movements under the guise of reluctance to certify its acceptance of the goods may still be able to do so by illegitimately refusing to add its block to the chain, but the speed and transparency of the blockchain transaction should produce the result that the seller should no longer be so vulnerable to the risk of deliberate manipulation of the process by the buyer.Previous attempts to replace paper documents with electronic ones in trade payments, such 3.35 as the proprietary BOLERO or SeaDocs experiments, have relied on the use of some form of central registry recording successive transactions with the relevant commercial documents. They have not been successful, despite decades of effort, partly because of commercial parties’ mistrust of central registries, and partly because of the systems’ reliance on technology that was not widely or cheaply available. Because it decentralises the payment process and makes it available to anyone with a simple internet connection, blockchain may be the future of trade finance. If it is the future, it is likely to provide a sweeping solution to soft clauses in letters of credit by transforming the structure of international payment systems completely.
V.