As experts, the world over, battle to find an electronic system that is both commercially and legally acceptable to replace the current paper chain, it is easy to lose sight of the fact that, in finding an alternative for the paper-based transaction, we need not reinvent the wheel as many pundits would have us believe. Indeed many traders who already conduct large areas of business electronically are alarmed at suggestions from some pundits that they need to advance a new and complex set of transactional rules to replicate electronically the old and complex set of rules that have come into existence over the last century or so. The latter seems to be a fundamentally flawed approach. The key to persuading the world’s trading and banking communities to embrace the full potential of online transactions is to show that what is happening is, in practice, evolution and not revolution.
Paper – The Old Solution – Not the Problem
Paper is not a problem that requires a solution – it is simply an old solution to a problem. The early trader’s contract was based on a handshake or a verbal exchange (and often is to this day). As the motto of one of the principal international trading associations, GAFTA, puts it, ‘my word is my bond.’ Paper needs to change hands in trade only as a means of evidencing what is already agreed and binding.
Those early traders enjoyed a truly paperless international trade system. To distinguish between real and imaginary problems surrounding the abandonment of paper for online trading and settlements, therefore, it helps us if we recognise where the different paper elements were introduced into the system and why.
What Purpose Does the Paper Serve?
Most elements in the paper chain were introduced to alleviate practical problems that had emerged as trade progressed. Paper money replaced gold when carrying it around the world became a tedious not to mention dangerous chore that attracted pirates and tied up precious financial reserves during the course of a sea voyage. Governments also found it financially expedient to persuade their citizens to exchange their pots of gold for state-issued and comparatively worthless paper and metal coinage, thereby giving the state control over trading activities through exchange and other mechanisms.
Expansion of trade in the meantime meant that the owner had to entrust the carrier with the goods and allow it to oversee the delivery to the buyer at the specified destination, because the carrier’s representative, the master, and not the seller, would be present on board the vessel at that destination. The bill of lading therefore emerged as a receipt, initially, developing its other well-known characteristics as time went on.
Letters of credit were introduced much later as a mechanism for balancing the financial risks of the buyer, who had to give value for these various pieces of paper, and the financial and security risk of the seller and the bank financing the transaction once goods had been shipped.
The Real Problem for Technology to Solve
The core problem then is not to find a technological solution to the replacement of certain pieces of paper. The real problem is how we confirm and evidence or replace that handshake or verbal agreement; how we guarantee payment of the price in exchange for evidence of the shipment of the goods (or physical delivery of the goods); how we ensure that only the person who is entitled to collect the goods at the quay side, airport, or railway siding actually gets them; and, most important, how we secure the interests of the banks financing the transaction until payment is received by them.
Facing these problems with fairly limited technological resources, on the whole, the early traders did a reasonably good job. Paper and ink were the technologies of the day. With our talent and the opportunity offered by the Internet, we can and should do much better. I want to concentrate on how we solve the crucial payment and security issues in electronic trade finance. So, let us look at the system we already have in our predominantly paper-based world and see whether it is readily adaptable to the needs of Internet-based trade finance.
The Current Documentary Credit System
Despite some failings and inefficiencies, the letter of credit is the international trade success story of our time. Importantly, and unlike the ‘handshake’ question, it is governed by an internationally accepted set of rules, currently the Uniform Customs and Practice for Documentary Credits (1993 Revision) ICC Publication No. 500 (UCP 500). These are applied throughout the world where UCP 500 terms are incorporated into letter of credit transactions. Equally important, save in the USA where UCP 500 is incorporated into law through the Uniform Commercial Code, UCP 500 is not a creature of or a slave to the statute law of any individual country. Amendment to it can and regularly does take place on a case-by-case basis to suit individual contractual needs. The same could not be said of the British Sale-of-Goods legislation governing the underlying transaction, for example. Certain aspects of sale-of-goods legislation cannot be contractually excluded. UCP 500 gives us a flexible non-statutory starting point.
UCP 500 has also helped to establish the autonomy of the credit as a principle of paramount importance to those involved in the international sale and purchase of goods, and to those financing those sales and purchases; namely, that the payment guaranteed under the credit to the seller will be made, in the absence of clear evidence of fraud, regardless of any argument that may be made regarding the physical goods or services in the underlying contract between the parties. Being the ‘life blood of commerce,’ as the letter of credit is often called, no one in their right mind would want to tamper with it needlessly. ‘If it ain’t broke don’t fix it’ is a cry heard whenever venerable institutions are modernized. In the case of UCP 500, however, few would seriously argue with the assertion that it needs to be substantially overhauled if it is to continue to be, as I believe it should, the linchpin of online electronic trade finance.
I say this because the basic principles of autonomy that the UCP 500 and its predecessors have helped to establish in the minds of all parties to international trade must be the bedrock of the future development of international trade and the settlement of payments under international trade transactions, if confidence is to be maintained. Achieving a truly independent mechanism for the payment of the price of goods sold internationally is an achievable goal if the right decisions are made now.
Problem Areas in the UCP 500
Some key issues that have been problems in paper-based credits will be just as crucial to the relevance and adaptability of UCP 500 in coping with online transactions. These include; • jurisdiction and place of performance, • discrepancies in documents, originality of Internet documents, • authentication and identification of parties involved in on-line transactions including money laundering risks, and • recourse against parties; the letter of credit fraud exception and its future.
Jurisdiction
The above are, of course, merely a few of the many issues that quite properly need to be addressed. The jurisdiction question, however, needs to be examined with some urgency. One of the UCP 500’s greatest attractions is also a potential area of danger. The UCP 500 is a ‘stateless’ set of rules. It contains no proper law or jurisdiction clause. The geographical location of the courts where disputes under a letter of credit will be dealt with depend on a complex relationship between the location of the issuing bank (and any negotiating or confirming bank), the beneficiary, the place of payment and/or the first inspection of the documents, and the relevant provisions of the Brussels and Rome Conventions.
The apparent uncertainty in that arrangement is not as bad as it first appears in that parties can ensure, by accepting only a credit that is issued or at least negotiable in an acceptable jurisdiction, that any dispute will be resolved in that particular jurisdiction. However, an argument is still raging as to whether jurisdiction can nonetheless be changed by the beneficiary calling for payment to be made to a different jurisdiction altogether (the Court of Appeal says as much in Chailease Finance Corporation –v- Credit Agricole Indosuez), as was reported in a past edition of L/C Monitor.
Here in England we have benefited from a rich tradition of judicial decisions that affect the relations between different parties under UCP 500. While we can take some steps to ensure that the credit will be litigated upon – if it proves necessary – in England, there is an uncertainty here that is at odds with the huge degree of certainty and definition we insist upon in all other contractual dealings. As many traders will tell you, the letter of credit is in their eyes ‘the contract.’ It is the instrument that causes payments to be made, which is, after all, what trade is all about.
The introduction of online credits will probably challenge these jurisdictional assumptions yet further. This is partly because the need for a complex network of advising and confirming banks will no longer be obvious. Electronic presentations of e-documents will take place through the Internet without the involvement of legions of correspondent banks. The old ‘safeguards’ will not be as readily available. It may become necessary to provide that jurisdiction and proper law are expressly allocated in order to avoid dispute. This will be even more important if, as I expect, the inspection of the e-documents becomes a function carried out by an independent trustee financial institution. This happens to some extent already. Although documents may be formally presented in Singapore, the negotiating bank may cause them to be first inspected in an outsourced document checking centre in Hong Kong. The link between the place where credits are booked and the place where the central inspection function occurs has therefore become a tenuous one.
The Court of Appeal in Credit Agricole Indosuez –v- Chailease clearly looked upon the place of payment as the central feature of the credit in determining jurisdiction. Nominating jurisdiction, or - if that is considered too controversial - at least providing a much more defined system for determining jurisdiction, could erase that area of uncertainty. In a system with centralized payment and distribution with no immediate geographical connection to the parties, this would be a necessity. In any event, parties are free at present to nominate a specific proper law and jurisdiction in their credits.
The ‘Original’ Question
When UCP 500 was issued in its revised form in 1993, among the thorny problems that the ICC had tried to deal with in Article 20 were some of the technological advances in the reproduction of paper documents which had rendered terms such as ‘original’ relatively meaningless.
As I have discussed in this column previously, the stance taken by the ICC in Article 20 underlined that this had in fact become the case. Article 20 has spawned a number of high-profile disputes over the status of documents originally from a computer. The Glencore –v- Bank of China case concerned a computer-produced document that was held to be discrepant because it was not stamped ‘original.’ The courts redeemed themselves and Article 20 to some degree with the common-sense decision in the Kredietbank Antwerp –v- Midland Bank case where the court adopted a more liberal and certainly less literal interpretation of what passes for an original document. However, these decisions underscore that unless bankers are to be required to exercise detailed forensic judgment on individual documents, they can never be expected to tell the precise difference between an original document (in the sense we all used to understand it) and a copy document produced by technological means, unless one were to have the words ‘original’ emblazoned across it and the other did not.
The ownership of a small rubber stamp with the word ‘original’ on it became a necessary part of the international trader’s documentary preparation, simply to deal with this issue.
Even if electronic credits were not beckoning, this is one section of UCP 500 that would clearly require major surgery to prevent the accusation that the rules had become bogged down in a very twentieth century problem.
In reality, provided electronic documents have been transmitted in the correct format and within the required security regime, the only question will be whether the content of the e-document complies with the requirements set out in the credit. The ‘original’ debate will close to loud cheering from the banking community.
Robert M. Parson is a solicitor and partner in the leading international trade law firm Middleton Potts in London. He both advises and regularly lectures to traders and bankers on trade and related finance law. Parson is one of the founding members of the International Trade & Banking Institute, www.cceweb.com/itbi