Letter of Credit Law Developments Prepared for CBA Commercial & Financial Transactions Committee January 19, 2006 Chicago, Illinois by Carter H. Klein Jenner & Block LLP 312 923-2950 [email protected] Chicago • Dallas • New York • Washington, DC www.jenner.com Jenner & Block LLP Letter of Credit Developments CBA Commercial and Financial Transactions Committee January 19, 2006 Chicago, Illinois Carter H. Klein1 Jenner & Block LLP [email protected] I. Background facts about letters of credit: A. U.S. banks and U.S. branches of foreign banks had issued and outstanding over $500,000,000,000 in letters of credit at the end of second quarter of 2005. Most of this amount is in the form of standby letters of credit. B. Over $1,000,000,000,000 in international trade is paid for each year by use of letters of credit. C. There is a high degree of concentration of LC business in a handful of banks. Although there are over 7,000 banks in the United States, 10 banks accounted for 75% of the dollar amount of all letters of credit issued by U.S. banks. D. In order of precedence, these banks are JPMorgan Chase, Bank of America, Citibank, Wachovia, Suntrust, Bank of New York, US Bank, Key Bank, Wells Fargo, and Comerica Bank. E. Although there are dozens of different uses for letters of credit, the largest dollar amount uses for letters of credit are as security posted by corporations and businesses to insurance companies for fronting workmens compensation insurance and other self-insured retention limits and by nonadmitted reinsurance companies to originating insurers to secure reinsurance obligations for capital adequacy and claims payment purposes. • 1 Carter H. Klein is a partner at Jenner & Block LLP where he has practiced commercial law for the past 31 years. He is a member of the American College of Commercial Finance Lawyers, Chair of the American Bar Association’s Letter of Credit Subcommittee, Editor, Uniform Laws Annotated – Uniform Commercial Code Forms Annotated (Thomson/West), and a member of the editorial advisory board for Documentary Credit World. He participated in the drafting of the International Standby Practices (1998) and Revised Article 5 of the Uniform Commercial Code and is a frequent speaker and articles contributor on letter of credit and Uniform Commercial Code topics. II. Types of Letters of Credit: A. Commercial letters of credit to pay for goods in international trade. B. Standby letters of credit used as security for an obligation, including . 1. Direct pay 2. Nondirect pay or true standby C. Clean letters of credit (only a draft need be presented -- usually required by insurance companies). E. Automatically renewing / evergreen letters of credit 1. Automatically renews 2. Automatically renews and reloads F. Presentment letters of credit -- the original LC must be presented G. Nonbank issued letters of credit -- Target, Walmart, JC Penny’s, commercial factors, insurance companies H. Straight and negotiable letters of credit -- standbys are not usually negotiable I. Transferable letters of credit J. Advised and confirmed letter of credit 2 III. Regimes Which Govern or Apply to Letters of Credit: A. UCP 500 (ICC Publication 500 -- 1993) 1. ISBP (International Standard Banking Practices) 2. eUCP (electronic presentments) 3. ICC Position Papers 4. IFSA Standard Banking Practice for the Examination of Documents B. ISP 98 (ICC Publication 590 -- 1998) C. UCC Revised Article 5 (also selected provisions of Articles 1 and 9) D. OCC Interpretation 12 CFR 7.1017 E. UNCITRAL Convention on Independent Bank Guarantees and Standby Letters of Credit (ratified by only 7 small countries) F. SWIFT 3 IV. Uses of and Alternatives to Standby Letters of Credit: A. Uses. Standby letters of credit have been used to secure obligations in connection with the following types of transactions: 1. Workmen’s compensation insurance fronting arrangements 2. Surety bonds 3. Commercial paper 4. Municipal or IRD bonds 5. Power plant construction 6. Other construction contracts 7. Open account indebtedness 8. Government permits 9. Government contracts 10. Cable installation obligations 11. Purchase price holdbacks 12. Advance payment guarantees 13. Bank guarantees 14. Environmental clean-up 15. Executive compensation 16. Reinsurance obligations of nonadmitted reinsurers 17. Financial contracts such as SWAPs 18. Forward Contracts (e.g., power purchase agreements) 19. Clearing obligations (e.g. CBOT) 20. Road and subdivision improvements 21. Obligations to consumers or the public 22. Supersedeas in lieu of appeal bond 23. Pre-judgment attachment security 24. Injunction security 25. Preliminary arbitration awards 26. Office lease security 27. Equipment lease security 28. Securitizations 29. Oil for food and medicine (Iraq) 30. Exchange of prisoners (Cuba) 31. Others 4 B. Alternatives to Letters of Credit 1. Surety bond 2. Financial guarantee insurance (MBIA, Ambac, ACA, FSA, FGIC) 3. Export insurance (Coface) 4. Cash deposits 5. Government securities collateral 6. Other collateral 7. Independent or other bank guarantee 8. Prepayment 9. Documentary collection 10. Open Account 11. C.O.D. 12. Set-off and netting 13. Structured finance and securitization 5 V. UCP 600 A. For several years the UCP’s banking Commission has been working on a redraft of the UCP 500. 52 national committees and subcommittees were formed to study and obtain comments and suggestions on what changes should be made to the UCP 500. B. There was by no means universal support for revising the UCP 500. The UCP had been working for 10 years. The International Standard Banking Practices or ISBP consisting of 200 paragraphs was issued by the ICC Banking Commission only a few years ago (Oct. 2002), after many man-hours of work and input by a special ICC task force working with national committees in putting it together. The ISBP supplements, explains provisions of and in some cases, updates the UCP 500. After this recent great effort addressing current issues facing the UCP, why would a new UCP be necessary? In addition, a new UCP would mean retraining and re-educating bank personnel and corporate and business users of letters of credit, modifying forms and language to be used going forward, revising the ISBP, and undergoing a considerable transition period. C. It is now apparent that a new draft will be adopted by the ICC, whether called the UCP 600 or some other number. The first full draft was issued on November 5, 2005 and the national committees are submitting their comments on it, which are due in less than a week -- January 25, 2006. D. Set forth on the next several pages is a copy of an internet article prepared before the new draft UCP 600 was issued. It highlights some of the more significant changes in the UCP that were anticipated and discussed by the national committees. It is annotated with my comments on what the new draft actually does or does not say with respect to the anticipated changes outlined. 6 UCP 600: The end in sight? Roger Kreitman, Principal Consultant, Mantissa October 20052 At a recent meeting of the UK Export Forum, Gary Collyer, head of the ICC drafting group, gave a progress report on the drafting of the long-awaited UCP 600 It is clear that there are still strong differences of opinion among the country committees on a number of important issues. The drafting group tried to resolve these by putting various proposals to the vote; but many of these votes only served to highlight the absence of a clear consensus or majority view. Meetings and discussions continue, and I have been told that a "more definitive" first draft of all the articles may be expected in the next few weeks. In the meantime, here are some samples of the drafting group's current thinking. It should be emphasized that this is all highly provisional in nature, and that much may still change during the revision cycles that are scheduled for the next few months. 1. The expression 'on its face' (in the context of document examination) has long been a source of confusion - for example, it can be taken to mean the front of the document as opposed to the back. So the current thinking is that the next UCP will have no references to 'on its face' It does. The phrase is retained in the latest draft. 2. Time limits for examination of documents. The current formulation is 'a reasonable time, not to exceed seven banking days'. The phrase 'reasonable time' will probably be removed. It is hoped that the maximum time for examination will be reduced to either five days or six days. Five days is the time limit; reasonable time requirement is removed. The 5 day maximum period for examination of documents does not depend on any upcoming expiry date or latest date for presentation. 3. There has been extensive discussion on whether UCP should refer to the issuers, advisers of L/Cs etc. as banks or as parties. Current thinking is that the term 'banks' should be retained, notwithstanding the recognition by the ICC that non-banks can issue L/Cs - as is commonplace for larger US companies when dealing with suppliers in Asia. • 2 Bold italicized comments after numbered discussion points are comments by Carter Klein based on the November 5, 2005 draft of the UCP 600. 7 The term “bank” is retained, but is defined as not limited to an entity traditionally known as a bank or other financial institution. 4. There is a majority view that that the practice of discounting deferred payment undertakings should be recognized by the new UCP. However the drafting of an appropriate article will require considerable thought! Deferred payment is now recognized. 5. It is likely that the obligations of the Advising bank will be expanded.