Chapter 4: International business transactions: risk and payment

Chapter learning objectives

Upon completion of this chapter you will be able to:

• explain and be able to apply the rules relating to the passing of risk under the United Nations Convention on Contracts for the International Sale of Goods 1980 (UNCCISG)
• define and explain the operation of bills of lading
• explain the operation of (i) bank transfers, (ii) bills of exchange, (iii) letters of credit, (iv) letters of comfort
• explain and be able to apply the rules of UNCITRAL Model Law on International Credit Transfer
• explain and be able to apply the rules of the United Nations Convention on International Bills of Exchange and Promissory Notes.

1 Passing of risk

Risk in goods means the responsibility for them, particularly if things go wrong and, e.g. insurance is required.

Illustration 1 – Passing of risk

Javine and Katrina had a contract for the sale of goods. Katrinaput the goods on a ship to be delivered to Javine, who was going tocollect them at the port at the other end of the journey. During thevoyage, there was a storm and the ship containing the goods was sunk.The key question is who was responsible for the goods at the time theywere sunk and therefore who bears the cost of the loss. The ICCIncoterms discussed earlier help determine when risk passes. E.g. ifJavine and Katrina had a FOB or a FAS contract, then Javine would havebeen responsible for the goods when the ship sank. However, if they had aCIF or a CIP contract, it is likely that Katrina would have beenresponsible.

Test your understanding 1

Define the following types of contract:

IFOB

II FAS

IIICIF

IVCIP

Test your understanding 2

Explain why the passing of risk is important.

Contracts involving carriage

• If the contract does not specify a place where the seller is going to hand over goods to the buyer, the risk passes to the buyer when the goods are given to the first carrier (Article 67(1)).
• If the contract specifies the place at which the buyer is going to hand over the goods to the first carrier, the risk passes to the buyer when the goods are given to the first carrier at that place (Article 67(1)).
• In the above cases, risk only passes to the buyer if the goods are clearly identified to the contract (by markings or by shipping documents) (Article 67(2)). In UK, identification of goods usually involve appropriation of the goods to the contract.
• Goods may only be appropriated to the contract if they are clearly identified and separated from other goods.

Illustration 2 – Passing of risk

Leo and Michelle have a contract for Leo to deliver goods toMichelle by sea and road. Leo places goods with Dolphin Shipping, atNewtown on 24 June to be delivered to London port. The goods will betransferred to Truckers Ltd after they reach the port.

The contract between Leo and Michelle makes no reference to whenrisk passes. Risk passes on 24 June when the goods are placed withDolphin Shipping (the first carrier), assuming that the goods areclearly appropriated to the contract.

If the contract between Leo and Michelle had made reference towhich port the goods should have been shipped from, then risk would passwhen the goods were placed with the first carrier at that place. So forinstance, if Michelle had specified that the goods be shipped fromOldtown, then Leo would have had to ship the goods from there, and if heshipped them from Newtown, risk would have remained with him.

Test your understanding 3

Noelle and Oscar have a contract for Noelle to deliver goods fromLa Rochelle by sea to London, where Oscar will collect the goods.Assuming the goods are clearly appropriated to the contract and that thecontract makes no further reference to risk, risk passes to Oscar:

Awhen the goods leave Noelle’s premises.

Bwhen the goods pass the ship’s rail in La Rochelle.

Cwhen the goods are collected by Oscar in London.

Dwhen the goods arrive at Oscar’s premises.

Test your understanding 4

Peter and Quinine have a contract for Peter to deliver goods toQuinine by ship. As the route is unusual, the goods will be transportedby three shippers: Marine Enterprises, who will collect the goods fromPeter and deliver them to the next carrier, Swift Shipping Co, who willaccept the goods from Marine Enterprises and ship them to a nameddestination, then Caribbean Carriers Co will collect the goods from thatdestination and deliver the goods to Quinine.

When will risk pass to Quinine?

Goods sold in transit (Article 68)

• Risk in goods in transit passes to the buyer when the contract is concluded.
• If circumstances indicate, risk passes to the buyer when the goods were handed to the carrier who issued the documents relating to the contract of carriage.
• If at the time of the sale the goods were lost or damaged and the seller knew or ought to have known this, risk remains with the seller.

Illustration 3 – Passing of risk

Rashid and Sam are contracting for Rashid to buy a consignment ofkitchen utensils from Sam. Sam has recently bought the utensils and theyare in transit from Country A to Country B by sea. Sam has not had achance to inspect the goods and will not have the chance to inspect themuntil he arrives in Country B on 5 June. Rashid wants to collect the 20boxes that he has bought on 4 June. Rashid and Sam agree terms on 1June. Risk in the goods therefore passes to Rashid on 1 June, as Sam hasnot had a chance to inspect the goods and therefore could not know ifthe goods were damaged. Rashid should make suitable arrangements toinsure the goods from 1 June.

Test your understanding 5

When does risk pass to the buyer in a contract to buy goods in transit?

Test your understanding 6

Trevor and Uhuru are in contract negotiations for Uhuru to buy aportion of a consignment of cans of peaches from Trevor. Trevorpurchased the goods in Sudenten, where he inspected them and they werein good condition. The goods are being shipped on Trevor's own boat, andhe has received no notification of any problems with the journey.Trevor has agreed to deliver Uhuru's portion of the cargo to a differentcarrier when he arrives in Nordesten, whereupon the goods will bedelivered to Uhuru in Weston.

Risk passes to Uhuru:

AIn Sudenten

BOn Trevor’s boat in transit

CIn Nordensten

DIn Weston

Other cases

• In other cases, risk passes to the buyer when he takes over the goods (Article 69(1)).
• If the buyer does not take over the goods at the appropriate time, the risk passes when the goods are placed at his disposal and in not collecting them, he is in breach of contract (Article 69(1).
• If the buyer is due to collect the goods from somewhere other than the seller's premises, risk passes when delivery is due and the buyer is aware that the goods are placed at his disposal at that place (Article 69(2)).
• If the goods are not appropriated to the contract, then risk does not pass until the goods are clearly appropriated to the contract (Article 69(3)).

Illustration 4 – Passing of risk

Wilfred and Xylon have a contract for Wilfred to provide Xylon with1,000 leather bags. The contract states that the goods should be madeavailable for Xylon to collect from Wilfred's factory on 1 June.

Risk will pass to Xylon when he collects the goods from Wilfred'sfactory on 1 June. If Xylon is late in collecting them, risk will stillpass to him on that date. So, e.g. if Xylon cannot collect the goodsuntil 2 June and the factory burns down on the evening of 1 June, Xylonmust still pay for the goods and bear the loss of the goods, becauserisk had passed to him.

Test your understanding 7

Yazmina and Zara have a contract for Zara to sell Yazmina 1,000metres of a fabric made to Yazmina's design. Yazmina is due to collectthe goods from a third party within a week of Zara making Yazmina awarethat the goods are available there. Zara delivers the fabric to thethird party premises on 1 June. She telephones Yazmina to tell her thegoods are available there on 2 June. Yazmina inspects the fabric on 5June, but as she wants to transport it in a different vehicle, she doesnot collect the fabric until 6 June.

Risk passes to Yazmina on:

A6 June

B5 June

C2 June

D1 June

Test your understanding 8

Abdul and Bruce agreed a contract for Bruce to buy 20 tonnes ofcoal by collection from the premises of a third party on 30 May. Abdulis storing 100 tonnes of coal at the third party premises. The coal isstored in a heap. Abdul contacts Bruce on 1 June and tells him that hemay pick up the coal from the third party premises any time during thefollowing two weeks. Bruce sends his lorries on 4 June. The coal isloaded on the lorries that afternoon, but Bruce does not take the coalaway until 5 June.

Risk passes to Bruce on:

A30 May

B1 June

C4 June

D5 June

2 Bills of lading

A bill of lading is a document which is issued by a carrier to theshipper acknowledging that they have received the shipment of goods andthat they have been placed on board a particular vessel which is boundfor a particular destination. It states the terms on which the goods areto be carried.

The bill of lading can therefore be an important document in determining when risk has passed from buyer to seller.

There are four types of bills of lading:

• Inland bill of lading: this is a contract for transporting goods overland to an exporter's international carrier.
• Ocean bill of lading: this is a contract for transporting goods from an exporter to a specified foreign market overseas.
• Through bill of lading: this is a contract that covers both the inland and the international transport of goods.
• Airway bill: this is a contract for both international and domestic flights to a specified destination. This is a non-negotiable document that only serves as a receipt for the shipper.

Illustration 5 – Bills of lading

This is an example of an airway bill.

A bill of lading has three purposes:

• It is a formal receipt by the ship owner for the goods.
• It is evidence of the contract of carriage between the original parties to the bill of lading and a contract of carriage between the carrier and a third party.
• It is a document of title to the goods.

There are two general types of bills of lading:

A non-negotiable bill of ladingrequires the carrier to deliver the goods to the consignee (buyer)named in the bill of lading. The person to whom the goods are being sentnormally needs to show the bill of lading to obtain the release of thegoods. An airway bill is an example of a non-negotiable bill of lading.

A negotiable bill of ladinggives the person who has legal ownership of the bill the ownership ofthe goods and the right to re-route the shipment. These are issued toshipper's order rather than to a named consignee (the buyer). Thecarrier will therefore hold the goods until it receives the originalbill of lading that has been endorsed by the seller. The seller mustendorse the bill of lading and deliver it to the bank in order toreceive payment if the payment is made by the letter of credit.

Think back to the seller's obligation (set out in chapter 3) to handover the appropriate documents to the buyer. The seller needs to ensurethat the buyer has the bill of lading to obtain the goods.

Test your understanding 9

Define a bill of lading.

Test your understanding 10

Define a non-negotiable bill of lading.

Test your understanding 11

Define a negotiable bill of lading.

Test your understanding 12

Ahmed (seller) is sending goods to Beatrice (buyer) by sea under a negotiable bill of lading. The shipper is Carriage Inc.

Answer the following questions relating to this shipment.

(1)Carriage Inc has heard thatthere are shipping delays on the proposed route due to bad weather. Thecompany has recommended that the goods be shipped by a different route.Who has authority to confirm the re-route of the goods?

(2)Beatrice will be able to collect the goods from the docks with no further action from Ahmed.

(3)Ahmed must endorse the bill of lading and present it to the bank to receive payment.

3 Methods of payment

Paying for goods in international transactions can posedifficulties where people come from nations with different bankingpractices, and even making bank transfers across national boundaries ismore difficult than for domestic bank transfers. We shall look at thefollowing types of payment:

• bank transfers.
• bills of exchange.
• letters of credit.
• letters of comfort.

The United Nations (UN) has two further conventions/model laws on payments which we shall also look at:

• UNCITRAL Model Law on International Credit Transfer 1992.
• UN Convention on International Bills of Exchange and International Promissory Notes 1988.

4 Bank transfers

The UNCITRAL Model Law on International Credit Transfers defines acredit transfer as 'the series of operations, beginning with theoriginator's payment order, made for the purpose of placing funds at thedisposal of a beneficiary. The term includes any payment order issuedby the originator's bank, or any intermediary bank intended to carry outthe originator's payment order' (Article 2(a)).

Illustration 6 – Bank transfers

You are probably familiar with domestic bank transfers. Many peopleare now paid by direct bank transfer from their company's bank accountto their own. In these days of internet banking, many people make directbank transfers from their own accounts to pay bills. In principle,international bank transfers are the same as these domestic ones, withcertain added complications resulting from the fact that the transfer isbeing made across national borders.

5 UNCITRAL Model Law on International Credit Transfers

Categories of transaction covered by the Model Law

The Model Law covers credit transfers where:

• The sending bank and receiving bank are in different states (Article 1(1)).
• The credit transfer involves other entities that execute payment orders in the same way as banks as a normal part of their business (Article 1(2)).
• For the purpose of determining the sphere of application of this law, branches and separate offices of a bank in different states are separate banks (Article 1(3)).
• Note that the Model law allows the parties to a credit transfer to vary their rights and obligations under this Model Law by agreement (Article 4).

The definition of credit transfer was given above. The following definitions will also be useful:

• Payment order is an unconditional instruction by a sender to a receiving bank to place at the disposal of a beneficiary a fixed or determinable amount of money if the receiving bank is to be reimbursed by the sender and the instruction does not provide that the payment is to be made at the request of the beneficiary (i.e. the seller) (Article 2(b)).
• Sender means the person who issued a payment order (i.e. the buyer), but includes the sending bank (Article 2(e)).

Obligations of sender of payment order – Chapter III, Art.5

The key obligation of the sender is to pay the receiving bank for the payment order when the bank accepts it. Problems arise if:

• the person sending the payment order did not have authority to do so
• the payment order was forged.

There are three steps in the Model Law to prevent this happening:

• The sender is only bound by the payment order if the sender issued it himself or it was issued by another person who had authority to bind the sender (Article 5(4)(a) and (b)).
• A purported sender is bound if the payment order is subject to authentication procedures agreed between the sending and receiving banks, and the receiving bank had carried out this authentication (Article 5(2)(b)).
• A sending and receiving bank cannot agree between themselves that the purported sender is bound in this way if the authentication process is not commercially reasonable (Article 5(2)(a) by implication).

Bank transfers

Most banks have authentication procedures to ensure that banktransfers are valid, e.g. they might require pre-registration by acompany in order to enable that company to make bank transfers, and aspart of that process, might require a list of signatures from all thepeople authorised to initiate bank transfers, so that the signature canbe verified when the bank transfer is requested.

The Model Law in effect says that people are entitled to rely onthese procedures and, if having gone through the procedures, the bankaccepts the bank transfer, then the sender is bound by the transfer andmust honour it, even if it was incorrectly made.

The only way that a sender can avoid this situation is if it provesthat the payment order resulted from the actions of someone who was:

• not a present or former employee of the purported sender.
• not a person who had such a relationship with the purported sender that enabled that person to access the authentication procedure, unless it can be shown that the sender was at fault in allowing the authentication procedure to be found out through his own carelessness.

In other words, if a former employee requested a bank transferbecause he was aware of the authentication process, the sender isliable, because the authentication process should have been able to copewith former employees.

Sender's payment to receiving bank

For the purpose of UNCITRAL Model Law on International CreditTransfers, payment of the sender's obligation under art.5(6) to pay thereceiving bank occurs:

Aif the receiving bank debits an account of the sender with the receiving bank, when the debit is made;

Illustration 7 – UNCITRAL Model Law

B if the sender is a bank and the above does not apply:

Illustration 8 – UNCITRAL Model Law

Obligations of receiving bank other then the beneficiary's bank.

The receiving bank is required to execute a payment order that it accepts. Acceptance is indicated by:

• issuing a payment order to the beneficiary's bank to carry out the payment order received (Article 72(c))
• (in a funds transfer system that requires all payment orders received from other banks in the same system must be executed) by receiving such a payment order (Article 72(a))
• debiting the sender's account at the receiving bank for the value of the payment order (Article 72(d))
• giving notice of intention to the sender of acceptance (Article 72(b))
• failing to give notice that it does not accept the payment order within the required time (within one banking day of receipt) (Article 72(e)).

Execution is by:

• placing funds at the disposal of the beneficiary (i.e. in his bank account) (Article 10(1)), or
• if the receiving bank is not the beneficiary's bank, the receiving bank issuing a payment order to the beneficiary's bank, which is then obliged to place funds at the beneficiary's disposal (Article 8(2)).

Problems may arise with credit transfers, e.g. if there areinconsistencies in the payment order (e.g. the amount given in words andnumbers do not match) (Article 8(3), (4) and (5)). When this happens,the receiving bank is obliged to:

• notify the sender of the problem (Article 11)
• seek the assistance of the next receiving bank to complete the bank transfer if the problem arose at the receiving bank (Article 13)
• repay the sending bank the amount credited to it, with interest, if the credit transfer fails (Article 14).

Bank's liability for failure to perform one of its obligations

In addition to the money back (+ interest) guarantee outlinedabove, a bank may also have liability to pay additional interest if thecredit transfer is delayed through its fault (Article 17(1)).

Completion of credit transfer and its consequences

A credit transfer is completed when the beneficiary's bank accepts apayment order for the benefit of the beneficiary (Article 19). At thispoint:

• the matter becomes a private banking issue between the beneficiary and his bank
• the other banks in the process have fulfilled their obligations.

Test your understanding 13

Define international credit transfer.

Test your understanding 14

Define payment order, in the context of international credit transfer.

Test your understanding 15

On 7 May, Adrienne entered into a contract to buy some goods fromBailey and has agreed to pay by international credit transfer. She usesthe National Bank of Caru (NBC) and Bailey uses the National Bank ofDentur (NBD).

Adrienne instructs NBC to initiate a payment order to NBD for thebenefit of Bailey on 4 June. NBC sends the appropriate paperwork to NBDon that date. NBD has an account at NBC. NBC credits that account withthe amount due to Bailey on 5 June. NBD transfers the money to Bailey'saccount at NBD on 6 June.

I The credit transfer is initiated on:

A7 May

B4 June

C5 June

D6 June

IIThe credit transfer is accepted by NBD on:

A7 May

B4 June

C5 June

D6 June

IIIThe credit transfer is completed on:

A7 May

B4 June

C5 June

D6 June

6 Bills of exchange

A bill of exchange is an unconditional order in writing by one personto another to pay a specified sum to a specified person or bearer on aparticular date (s1(1) Bills of Exchange Act 1882). In essence, a billof exchange is therefore an IOU used in international trade.

Illustration 9 – Bills of exchange

A common example of a bill of exchange used by individuals whichyou may be familiar with is a cheque. The piece of paper itself has novalue, but the cheque will be cashed by the payee and the banker willpay the amount stated on it, on demand.

There are various terms associated with bills of exchange that help us see more clearly what one is. These are:

Definitions associated with bills of exchange:

• Drawer – the person who makes the order and draws up the bill.
• Drawee – the party on whom the bills is drawn, usually a bank.
• Payee – the person to whom the bill is payable.
• Acceptor – the drawee once he has assented to the bill. The drawer must accept in writing with a signature, a simple signature by the drawee is sufficient.
• Holder – the person who holds the bill (this might be the payee, the drawer or the drawee). There are three different types of holders: holders in due course, holders for value and mere holders.
• Endorsee – anyone to whom the bill is transferred to make them the beneficiary of the bill.

Illustration 10 – Bills of exchange

Returning to our simple illustration of the cheque (above), you cansee some of these terms in action. The drawer is the person who hasdrawn up the bill. On a cheque, you can see their name printed below thebox showing the numerical total. The drawer has to sign the cheque inorder to validate it. The drawee is the bank who has originally issuedthe cheque to the drawer. The name of this bank is shown clearly on thetop of the cheque. Once the drawer has written out the cheque and signedit, the bank becomes liable to pay the sum from the drawer's bankaccount. The payee is written in by the drawer on the first line, wherethe cheque says 'pay'.

Illustration 11 – Bills of exchange

Here is an example of an international bill of exchange

Once the drawee has signed the bill and thus accepted it:

• the drawee becomes the principal debtor on the bill
• the drawee is primarily liable to pay for it
• therefore the drawee will ensure prior to acceptance that the drawer has sufficient funds to pay the drawee the value of the bill of exchange.

A bill of exchange is a transferable and negotiable asset.

• The payee may sell the bill of exchange to another party.
• To entitle the other party to benefit from the bill (in effect, become the new payee) the payee must endorse the bill of exchange in favour of the new owner.
• This can be achieved by writing the new owner's name on the bill with the signature of the former payee.

Test your understanding 16

Define bill of exchange.

Test your understanding 17

Define payee in the context of bills of exchange.

Test your understanding 18

Define drawee in the context of bills of exchange.

Test your understanding 19

Define drawer in the context of bills of exchange.

7 UN Convention on International Bills of Exchange and International Promissory Notes

Scope of application and form of the instrument

As defined by the Convention, a bill of exchange is a writteninstrument which contains an unconditional order whereby the drawerdirects the drawee to pay a definite sum of money to the payee or to hisorder, which is payable on demand or at a definite time, is dated andis signed by the drawer (Article 3).

Per the Convention, a promissory note is a written instrument whichcontains an unconditional promise whereby the maker undertakes to pay adefinite sum of money to the payee or to his order, is payable on demandor at a definite time, is dated and is signed by the maker.

The Convention applies to international bills of exchange and promissory notes that contain certain required elements:

• The instrument must contain the words 'International bill of exchange (UNCITRAL Convention)' (Article 1(1)) or 'International promissory note (UNCITRAL Convention)' (Article 1(2)) whichever is relevant, in its heading and text.
• The bill of exchange must specify at least two of the following places and indicate that any two of them are situated in different states: the place where the bill is drawn, the place next to the signature of the drawer, the place next to the name of the drawee, the place next to the name of the payee, the place of payment (Article 2(1)).
• The promissory note must specify at least two of the following places and indicate that any two of them are situated in different states: the place where the note is made, the place indicated next to the name of the maker, the place indicated next to the name of the payee, the place of payment (Article 2(2)).

Interpretation of the Convention

The sum payable by an instrument is:

• deemed to be definite (although the instrument might state that it is to be paid with interest, or in instalments, according to a rate of exchange indicated in the instrument, or in a currency other than the one in which it is expressed in) (Article 7)
• the sum expressed in words if there is a discrepancy between the sum expressed in numbers and the sum expressed in words (Article 8(1))
• deemed to be expressed in the currency of the state where the payment is to be made if the exact currency is not specified and the currency specified is in general use (e.g. 'dollars', which is a different currency in the US, Canada, Hong Kong SAR, New Zealand and Australia) (Article 8(3)).

Interest payable under an instrument:

• is deemed to run from the date of the instrument, unless otherwise specified (Article 8(4))
• is deemed to be payable only if the rate at which it is to be paid is specified (Article 8(5))
• may be fixed rate or variable rate (the instrument may specify maximum and minimum rates if the rate is variable) (Article 8(6)).

An instrument is:

• payable on demand if it states so or if no time of payment is expressed (Article 9(1)(a) and (b))
• payable at a definite time if it states that it is payable on or after a stated date; at a fixed period after the date of the instrument; by instalments at successive dates or by instalments at successive dates with the stipulation in the instrument that upon default payment of any instalment the unpaid balance becomes due (Article 9(3)).

An instrument may be made by several parties and may be payable to several parties, in which case:

• it is payable to any one of the payees (Article 10(3)).
• any one of the payees in possession of the instrument may exercise the rights of a holder (Article 10(3)).
• unless the instrument is clear that it is payable to all of them (together) (Article 10(3)).

Transfers of the instrument

An instrument may be transferred:

• by endorsement (written on the instrument and signed) and delivery to the endorsee (Article 13(a))
• by delivery only if the last endorsement is in blank (a signature only) (Article 13(b)).

A holder is (i) the payee in possession of the instrument, (ii) aperson in possession of an instrument that has been endorsed to him,even if the endorsement was forged (Article 1(a) and (b)).

A protected holder is the holder of an instrument which was completewhen he took it (or incomplete when he took it, but it contained thewords 'international bill of exchange (UNCITRAL Convention)' in theheading and was signed and has since been completed with authority)provided that he is not aware of any problems associated with the bill.Holders are assumed to be protected unless the reverse is true (Article29).

If the endorsement is in blank (a signature alone, or a signaturestating that the bill is payable to the person in possession of it) theholder may:

• further endorse it in blank or by a special endorsement (signature accompanied by an indication of to whom the bill is endorsed) (Article 16(a))
• convert the blank endorsement to a special endorsement in his own favour (Article 16(b))
• transfer the instrument by delivery to another person (Article 16(c)).

Under Article 17(1) a bill cannot be transferred if the bill or an endorsement on the bill contains words such as:

• not negotiable
• not transferable
• not to order
• pay X only.

An endorsement:

• must be unconditional (or it will be deemed to be, even if it appears to contain conditions) (Article 18(1))
• must relate to the entire sum of the bills or it is ineffective (Article 19)
• is deemed to arise in the order in which it appears on the instrument (relevant if there are two or more endorsements) (Article 20).

Under Article 21(1) an endorsement containing the words 'forcollection', 'for deposit', 'value in collection', 'by procuration','pay any bank':

• authorises the endorsee to exercise all rights of the instrument (Article 21(1)(a))
• may endorse the instrument only for the purposes of collection- (Article 21(1)(b))
• makes the endorsee subject only to the claims and defences which may be set up against the endorser (Article 21(1)(c))
• makes the endorsee not liable on the instrument to any subsequent holder (Article 21(2)).

Under Article 22(1) an endorsement containing the words 'value insecurity', 'value in pledge', or any other words indicating a pledge:

• authorises the endorsee to exercise all rights of the instrument (Article 22(1)(a))
• allows the endorsee to endorse the instrument only for the purposes of collection (Article 22(1)(b))
• makes the holder subject to particular claims and defences set out in Article 28 or 30 of the Convention (see below) (Article 22(1)(c))
• makes the endorsee not liable on the instrument to any subsequent holder (Article 22(2)).

Transfer warranties

Unless otherwise agreed, a person who transfers an instrument makes an implied representation that:

• the instrument is of a good quality (i.e. it does not bear any forged or unauthorised signature and has not been materially altered) (Article 45(1)(a) and (b))
• there are no facts that could impair the right of the transferee to payment of the bill (Article 45(1)(c)).

A holder has rights to the instrument unless:

• he took the instrument with knowledge of a valid claim by another person (Article 45(2) by implication)
• he obtained the instrument by fraud
• he obtained the instrument by theft.

Liabilities of the parties

The following rules apply with respect to liability in relation to a bill of exchange:

• A person is generally not liable on a bill of exchange unless he signs it (Article 33(1)).
• If someone signs a bill with a different name he is still liable as if he had signed his own name (Article 33(2)).
• If a person's signature is forged, that person is not liable on the bill unless he consented to the forgery (Article 34).
• If a bill is materially altered, the person who signs it after the alteration is liable according to the terms of the altered text (Article 35(1)(a)).
• A bill may be signed by an agent (so long it is clearly stated that he is signing on behalf of a principal, the agent will not be liable, and the principal will) (Article 36).
• The drawer undertakes to pay the bill if it is dishonoured (Article 38(1)).
• The drawer may limit his liability for acceptance or payment by an express stipulation in the bill (Article 38(2)).
• The maker undertakes to pay the promissory note under Article 39(1) and may not limit his liability under Article 39(2).
• The drawee is not liable on the bill unless he accepts it (Article 40(1)).
• Once the drawee has accepted the bill (which must be unqualified and written on the bill) he is liable on it (Article 40(2)).
• The endorser undertakes to pay the instrument to the holder if it is dishonoured (Article 44(1)).
• The endorser may limit his liability for acceptance or payment by an express stipulation in the bill (Article 44(2)).

Guarantees and avals

Payment of an instrument may be guaranteed under Art.46(1):

• The guarantee must be written on the instrument or attached to it (Article 46(2).
• By writing the words 'guaranteed', 'aval' or 'good as aval' or words of similar import (Article 46(3).

Other practical issues

The Convention allows a number of provisions to benefit modern commercial practice.

• Instruments with floating rates of interest: instruments are allowed to carry a variable rate of interest without losing negotiability.
• Rates of exchange outside instrument: reference may be made to a rate of exchange not specified in the instrument (e.g. the bank exchange rate in X country on X date).
• Instruments payable in instalments: instruments are allowed to specify payments in instalments on successive dates. These may contain an acceleration clause stating that in the event of a default in payment, the entire unpaid balance becomes payable.
• Instruments denominated and payable in a monetary unit of account: i.e. a currency other than the official currencies of nation states, such as the European Currency Unit (ECU) or the Unit of Account of the Preferential Trade Area for Eastern and Southern African States (UAPTA).
• Foreign currency obligations: except where the instrument indicates a specified currency in which the payment must be made, payment must be made in the currency in which the bill is expressed.

Further notes:

• Rules on lost instruments: a party from whom payment of a lost instrument is claimed may require the person claiming payment to give security in order to indemnify it for any loss which it may suffer by reason of the subsequent payment of the lost instrument (Article 78).
• Protest: the Convention allows four business days for protest to be made.
• Limitation on actions: the Convention sets the limitation on actions period at four years (Article 84(1)).

Test your understanding 20

Define international bills of exchange within the context of the UN Convention on such instruments.

Test your understanding 21

Define international promissory notes within the context of the UN Convention on such instruments.

Test your understanding 22

Emil has drafted a bill of exchange in favour of Fernando. There isa discrepancy between the sum written in numbers, which is '$30,000'and the written sum, which is 'thirteen thousand dollars'. Fernando willreceive:

A $30,000

B $13,000

Test your understanding 23

Gio, from Colombia, has drawn up an international bill of exchangein favour of Helen, from Chile, through an Argentine bank. The bill ofexchange states that it is for three thousand pesos.

Helen will receive:

A3,000 Colombian pesos

B3,000 Chilean pesos

C3,000 Argentine pesos

Test your understanding 24

Julio has drawn up an international bill of exchange in favour ofKathleen, which has been accepted by Julio's bank. Kathleen endorses thebill in favour of Leander, who in turn endorses the bill 'forcollection' in favour of Mary. Mary in her turn, endorses the bill 'forcollection' in favour of Nathan.

Which of the following is potentially liable on the bill.

AJulio

BJulio’s bank

CKathleen

DLeander

EMary

FNathan

8 Letters of credit

A letter of credit is an undertaking by a bank to make a payment to anamed beneficiary within a specified time, against the presentation ofdocuments which comply strictly with the terms of the letter of credit.

There are four parties to a letter of credit:

• The buyer, who is known as the applicant.
• The buyer's bank, which is known as the issuer or issuing bank.
• The seller/payee, who is known as the beneficiary.
• The beneficiary's bank. This will be the correspondent bank which may be advising only or confirming.

Illustration 12 – Letters of credit

A letter of credit:

• ensures that the seller has performed all the requirements of the underlying sales contract before payment is made
• is an autonomous transaction. According to the principle of autonomy of credits any conditions in the underlying contracts are irrelevant. Any condition, which the buyer wants to ensure is satisfied before payment is made, must be stipulated in the letter of credit itself
• provides security for the seller, as it promises that if the appropriate documents are presented to the bank, the seller will receive payment
• Provides security for the buyer, as it undertakes to examine the documents to ensure that all appropriate documents are tendered
• transfers the risk of non-payment to the buyer's bank, so long as the seller fulfils all his obligations, as the bank is bound to pay the money on presentation of the documents, even if the buyer does not pay the bank
• is therefore the most secure form of payment for the seller other than cash in advance.

Procedures

To create and use a letter of credit, the following steps would be taken:

• The exporter (seller) and importer (buyer) agree the terms of their contract.
• The buyer applies to their bank for a letter of credit.
• The buyer's bank (issuer) issues the letter of credit and sends it to the seller's bank (advising bank).
• The advising bank informs the seller that the letter of credit has been opened in his favour.
• The seller ships the goods.
• The seller presents the information required or the letter of credit (such as invoice, bill of lading) to the advising bank.
• The advising bank checks that the documents are the correct ones and, if so, pays the seller.
• The advising bank forwards the documents to the issuing bank.
• The issuer checks that the documents are the correct ones and, if so, pays the seller's bank.
• The issuer debits the buyer and releases the documents to the buyer, including the bill of lading so that the buyer can obtain the goods from the carrier.

Types of letters of credit

There are numerous types of letters of credit:

• Revocable: these can be amended or cancelled at any time prior to the payment being made by the buyer without the seller's consent. These therefore offer little protection to the seller and are rare.
• Irrevocable: these cannot be amended or cancelled without the agreement of all relevant parties (buyer, seller, banks). The ICC Uniform Customs and Practice for Documentary Credits states that all letters of credit falling within its scope are irrevocable unless otherwise stated (Article 6(c)).
• Unconfirmed: these are sent by the advising bank directly to the seller without guarantee that the bank will make payment, but confirming that the letter is valid.
• Confirmed: these contain an added confirmation by the advising bank that payment will be made so long as the compliant documents are presented by the seller. The confirming bank usually makes an additional charge for this service.
• Standby: this is a letter of credit used as support when a different, less secure method of payment has been agreed between the parties, so that if payment fails, the seller may claim payment by letter of credit.
• Revolving: this is used where there are regular shipments of the same commodity to the buyer so that a different letter does not have to be issued each time. The letter must state that it is revolving (either by time, until a set level of credit runs out, or by value, so that the same value is used each time).
• Transferable: this is one where the seller has the right to request that the paying bank make the payment to a third party (e.g. the person from whom the seller has bought the goods in question).
• Back-to-back: this is slightly more complex than a transferable letter of credit, and is where the original letter of credit is used as security to establish a second letter of credit in favour of the seller's supplier.

Test your understanding 25

Define letters of credit.

Test your understanding 26

An irrevocable letter of credit gives security to:

A The buyer

B The seller

Test your understanding 27

Explain the difference between a confirmed and an unconfirmed letter of credit.

Test your understanding 28

Alice, the buyer, is setting up a letter of credit topay Bernard, the seller, for goods he is shipping to her. What stepsmust Alice take?

9 Letters of comfort

A letter of comfort is a tool used assure a creditor that a third party will ensure payment of its debtor's debts.

Letters of comfort are generally used by parent companies toencourage potential lenders or clients to extend credit to theirsubsidiary companies by stating their intention to provided financialbacking for those subsidiary companies.

As such letters of comfort do not normally amount to actualpromises, remaining mere statements of intention, they cannot beaccepted so as to constitute a binding contractual agreement. As aconsequence the holders of letters of comfort have no legal recourse ifthe parent company subsequently fails to recognise and give effect tothem.

Kleinwort Benson Ltd v Malaysia Mining Corporation Berhad (1989)

Facts: Kleinwort Benson lent £5m to a Malaysian miningcompany and were provided with a letter of comfort from Malaysia MiningCorporation.

Held: The Court of Appeal held that the specific letter ofcomfort in this case, was not binding, apparently for the reason thatthe plaintiff was aware of the risky nature of letters of comfort andcharged additional interest on the loan. Nonetheless the court held thatin different circumstances a letter of comfort could form the basis foran action in breach of contract.

In effect, it is a reference to the bank from a third party on behalf of the buyer, who wishes to make the payment.

Chapter summary

Test your understanding answers

Test your understanding 1

IFOB stands for Free on Board. ThisIncoterm is specific to delivery by ship. The seller has delivered thegoods when they pass the ship's rail at the named port of shipment. Theseller bears the responsibility for clearing the goods for export, butthe buyer is responsible for the goods from when they are placed on theship and bears the costs from then on.

II FAS stands for Free Alongside Ship.This term is also specific to delivery by ship. In this case the selleralso has to bear export charges, but has delivered the goods once theyare standing alongside the ship at the port. The buyer is responsiblefor getting them on the ship and from them on.

IIICIF. This stands for Cost, Insuranceand Freight. This means the seller must pay the cost and freightinvolved in getting the goods to a named destination, but the riskpasses to the buyer when the goods are placed on the ship. In addition,the seller must pay for insurance to cover the goods when they are intransit. The seller need only pay for the minimum insurance, so if thebuyer wants more comprehensive insurance, the buyer must makearrangements for that. Higher-level insurance may also be stipulated inthe underlying contract.

IVCIP. This stands for Carriage andInsurance Paid. This means that the seller pays for the freight of thecarriage of the goods to the named destination. The seller is requiredto clear the goods for export. The risk passes from the seller when thegoods are at the named destination. In addition, the seller must pay forinsurance for the goods during carriage. Damage to the goods or loss ofthem after risk has passed to the buyer does not free him from the needto pay the price of the goods, unless the loss of damage is theseller's fault (Article 66). It is clear then that when the risk'passes' is an important issue. UNCCISG sets out the rules in Chapter IVtitled 'Passing of risk'.

Test your understanding 2

It is important that the parties to a contract know when riskpasses because they need to know when they are responsible for the goodsand will bear the cost of loss or damage. It will also be important inorder to determine who has the insurable interests in the goods andaccordingly who can claim under the insurance policy in case of loss.

Test your understanding 3

Test your understanding 4

Assuming that there is no extra provision in the contract for whenrisk passes and that the goods are clearly marked to the contract, riskwill pass to Quinine when the goods are placed with Marine Enterprises.

Test your understanding 5

Risk passes to the buyer when the contract is formed.

Test your understanding 6

Test your understanding 7

Test your understanding 8

Test your understanding 9

A document which is issued by a carrier to the shipperacknowledging that they have received the shipment of goods and thatthey have been placed on board a particular vessel which is bound for aparticular destination.

Test your understanding 10

A non-negotiable bill of lading requires the carrier todeliver the goods to the consignee (buyer) named in the bill of lading.The person to whom the goods are being sent normally needs to show thebill of lading to obtain the release of the goods.

Test your understanding 11

A negotiable bill of lading gives the person who has legalownership of the bill the ownership of the goods and the right tore-route the shipment. These are issued to shipper's order rather thanto a named consignee (the buyer). The carrier will therefore hold thegoods until it receives the original bill of lading that has beenendorsed by the seller.

Test your understanding 12

(1)Ahmed. As the bill is negotiable, he is the legal owner of it and has the right to authorise a different shipping route.

(2)False. Beatrice will notbe able to collect the goods until she can show the original bill oflading to the carrier, endorsed by Ahmed.

(3)True.

Test your understanding 13

The series of operations, beginning with the originator's paymentorder, made for the purpose of placing funds at the disposal of abeneficiary. The term includes any payment order issued by theoriginator's bank, or any intermediary bank intended to carry out theoriginator's payment order.

Test your understanding 14

Payment order is an unconditional instruction by a sender to areceiving bank to place at the disposal of a beneficiary a fixed ordeterminable amount of money if the receiving bank is to be reimbursedby the sender and the instruction does not provide that the payment isto be made at the request of the beneficiary (i.e. the seller).

Test your understanding 15

I4 June. The payment order is initiated by the sender's bank when it sends the payments order to the receiving bank.

II 5 June. The payment order is accepted when the credit is made in the receiving bank's account.

III5 June. The payment order iscompleted when the beneficiary's bank (NBD) accepts a payment order forthe benefit of the beneficiary.

Test your understanding 16

An unconditional order in writing by one person to another to pay aspecified sum to a specified person or bearer on a particular date.

Test your understanding 17

The person to whom the bill is payable.

Test your understanding 18

The person who makes the order and draws up the bill.

Test your understanding 19

The person who makes the order and draws up the bill.

Test your understanding 20

A bill of exchange is a written instrument which contains anunconditional order whereby the drawer directs the drawee to pay adefinite sum of money to the payee or to his order, which is payable ondemand or at a definite time, is dated and is signed by the drawer.

Test your understanding 21

A promissory note is a written instrument which contains anunconditional promise whereby the maker undertakes to pay a definite sumof money to the payee or to his order, is payable on demand or at adefinite time, is dated and is signed by the maker.

Test your understanding 22

B $13,000

Test your understanding 23

B 3,000 Chilean pesos

Test your understanding 24

Julio, Julio's bank, Kathleen and Leander. Mary and Nathan cannotbe liable to future holders, as they have endorsed the bill forcollection only.

Test your understanding 25

An undertaking by a bank to make a payment to a named beneficiarywithin a specified time, against the presentation of documents whichcomply strictly with the terms of the letter of credit.

Test your understanding 26

Security is given to both parties. The seller knows that he will bepaid for the goods and the buyer knows that the seller will have tofulfil the obligations of presenting the relevant documents to the bankbefore payment will be made.

Test your understanding 27

A confirmed letter of credit is one where the seller's bank hasadded its guarantee to the letter of credit that the seller's bank willpay the seller on presentation of the appropriate documents. Anunconfirmed letter of credit contains no such guarantee from theseller's bank, although the seller's bank does confirm that the letteris genuine.

Test your understanding 28

She must finalise the terms of her agreement with Bernard and thenapply to her bank for a letter of credit. Her bank will then issue theletter of credit to Bernard's bank.

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