IBC CONFERENCE

ELECTRONIC B2B TRADE - THE LAW, FINANCE AND THE SUPPLY CHAIN

 

TRADE FINANCE ON LINE – ARRIVAL POINT

ROBERT PARSON, PARTNER, MIDDLETON POTTS

 

 

Safe contracting and lending

 

When asked recently to talk about how we ensure that we contract and lend money “safely” over the Internet I was reminded of a newspaper article by an eminent doctor who pointed out – as if it needed pointing out – that there is no such thing as “safe sex” but merely “safe as we can make it” using the available methods of protection.  As any one in Government will tell you, by dealing in and promising absolutes you swiftly become a hostage to fortune.  The same is true of the paper based trading regime we all currently follow. 

 

We use all the available methods of protection to ensure that we record our transactions, effect our security and so on but international trade is an inherently risky business and always has been.  That is because human beings are principally – and fortunately – responsible for engaging in it and because as yet no one has discovered how to manipulate the elements as well as politics and the market place at the same time.  It is often the lack of perception of how great that risk is on the ultimate consumers part that leaves him/her unable to comprehend why he is paying the current market price for the product in the location where he purchases it.  Traders and bankers alike take a number of calculated risks along side the few absolutes that they can identify.  Political, environmental and human risks all play their part.  So when we assess how those risks will be dealt with in an electronic regime it is worth remembering that we move from a risk-laden system into the future and not from a perfect system. 

 

Documents of title

 

Perhaps the most problematic issue which has faced international trade over the past century has been the manner in which title and rights of action against the carrier of goods is transferred from one owner of goods to a subsequent owner of the same goods while the goods are in transit.  This is a problem that has vexed lawyers, bankers, insurers and the law courts of the world during that period and until the enactment, in the UK at least, of the Carriage of Goods by Sea Act 1992, the problems which surrounded for example, the passing of title through a bill of lading where the sea voyage was completed before the arrival at the discharge port of the bills of lading was the result of a variety of unsatisfactory albeit innovative legal decisions because the original legislation dating from the 19th century had relied on a connection between the right of an endorsee of a bill of lading to enforce his rights of suit and whether property in the goods passed to him “upon or by reason of” the endorsement of the bill which became untenable in modern commerce.  Under the current legislation any lawful holder of a bill of lading can require the delivery up of the goods. 

 

Before analysing how we can effectively pass title in goods on the water in an electronic format it helps to analyse what it is that the bill of lading does for us in its current form that we want to try and replicate electronically. 

 

As we all know the bill of lading classically performs three functions.

 

(1)      It acts as a receipt by the carrier for the goods that have been shipped on board.

 

(2)      It acts as evidence of the contract of carriage that has been agreed.

 

(3)      It performs the document of title function which bankers rely on for security under their pledge that we are now seeking to deal with in an electronic way. 

 

Dealing with the first two of those aspects first it is clear that there is no great problem in sight.  Recalling the terms of the contract of carriage and making their contents known to all those who might in future be effected by them when they inherit the rights and obligations contained in those terms is a relatively simple operation in the modern age using the secure communication technology we now enjoy.  The undertaking by the Master as to receipt of the goods in good order and condition is likewise easily dealt with by secure communication using the existing digital signature legislation which has been introduced in the UK and elsewhere in the EU.

 

What does a bill of lading do?

 

When we turn to the function of the bill of lading to transfer property in the goods described in it that matters become a little more complicated. 

 

Here in England, where the bill of lading is actually issued to the order of the Seller the Sale of Goods Act 1979 provides that property will only pass when a Seller is paid generally against the tender and endorsement of a bill of lading.  But where payment is by documentary credit, a pledge is created and this passes certain property rights to the bank when the Seller tenders the documents. 

 

However there is no inevitable connection between the transfer of the bill of lading and the passing of property because under Section 17 of the Sale of Goods Act 1979 the passing of property ultimately depends upon the intention of the parties.  Consequently it can be and often is determined by a specific provision in the contract of sale. 

 

One of the principal problems that has to be dealt with is the transfer of constructive possession in the goods.  Only the lawful holder of a bill of lading can require the carrier to deliver the goods to him and there are numerous legal authorities re-stating the principle that the carrier cannot deliver to any one else with impunity.  

 

On the face of it therefore the carrier could find himself liable if he delivers against something other than a paper document and therefore it is important that he knows precisely who it is at the port of discharge that he is legally entitled to deliver to. 

 

What do we need an electronic shipping document to do

 

So if we look at what the bill of lading is having to achieve in its function of document of title it needs to be able to ensure that

 

(1)      only the holder of an original title document should be entitled to delivery and the shipowner should be liable to him if he delivers to any one else;

 

(2)      a shipowner can refuse to deliver against anything other than the production of an original document; and

 

(3)      that the shipowner would be protected if he does deliver against the production of an original document

 

A certain number of these issues can be covered by express contractual provision.  The decision of the English Court in the “HOUDA” [1994] 2 LLR 541 and other decisions demonstrate that a Master is entitled to refuse to deliver without production of bills of lading in the absence of an express clause in the charterparty.  Such clauses are regularly seen in charterparties.

 

One of the tasks set to those who are looking for an electronic solution to the current bill of lading format is to provide the shipowner and other parties with the same obligations and rights that he would have under the current system described above.  Ultimately, if shipowners are not happy with these arrangements they will refuse to carry goods under them and likewise banks will be reluctant to lend money against them. 

 

CMI solution

 

As long ago as 1990 the CMI’s Rules for electronic bills of lading inspired by the late Bernard Wheeble produced a relatively straightforward solution.

 

(1)      Using a private key code system the original shipper (and any subsequent holder) would exercise a right of control and transfer on to any subsequent holder of the electronic bill of lading.

 

(2)      The rules also provided that the electronic message passing between the parties would perform all the evidential functions required of a traditional bill of lading including

 

(i)       the name of the shipper

 

(ii)      the description of the goods with any representations and reservations in the same tenor as would be required if a paper bill of lading were used

 

(iii)     the date and place of the receipt of the goods

 

(iv)     reference to the carrier’s terms and conditions of carriage

 

In addition to this the message would convey the private key to be used in subsequent transmissions thereby providing the code to allow the new recipient to either utilise the electronic bill of lading or pass it on to someone else. 

 

Problems with CMI proposal

 

There were some problems with this early attempt at setting out a standard rule for electronic bills of lading as Paul Todd commented in his updated section on De-materialisation of Shipping Documents in the second edition of Cross Border Electronic Banking.

 

These disadvantages included:

 

(1)      That the rules made no apparent provision for the transfer of contractual rights and liabilities along with the documentation meaning that the carried could on the face of it be refused to deliver to the new holder but only be subject to a claim by the original holder. 

 

(2)      The position of a holder who accepted the new bill but did not pay for the goods was unclear.  There is no equivalent of Section 19 Sale of Goods Act 1979 applicable to an electronic bill of lading.  In relation to a paper bill of lading where goods are shipped and according to the bill of lading the goods are deliverable to the order of the Seller or his agent the Seller is prima facie taken to reserve the right of disposal of the goods (Section 19 (2) ).

 

Where the Seller of the goods draws on the Buyer for the price and transmits a bill of exchange and a bill of lading to the Buyer to secure acceptance or payment of the draft the Buyer is then bound to return the bill of lading if he does not honour the bill of exchange and if he wrongfully retains the bill of lading the property and the goods does not pass to him (Section 19 (3) ).

 

(3)      Following on from that last point the CMI Rules actually make no provision for the passing of property in the goods though as we have seen from the Sale of Goods Act provision property does not necessarily pass in the goods with the document of title. 

 

(4)      The private key system was not by itself very secure technologically.

 

Since those particular criticisms of the CMI model were first raised there have of course been a number of developments in the way that secure messaging and direct contractual provision can be made to provide the same contractual privity provisions which mark out the bill of lading as a unique and versatile international trade instrument.

 

Firstly, the advancement in encryption techniques means that a system based on the CMI principle but using public and private key encryption to ensure the secrecy of the codes avoids the situation where a stranger to the transaction fraudulently avails himself of the electronic information required to obtain delivery.

 

Secondly, messaging techniques using the same secure system will enable the carrier to make direct and complimentary contractual provision with the new holder of the electronic bill of lading so as to effectively transfer all the same rights and obligations entered into with the original shipper to the ultimate receiver thereby breaking out of the one disadvantage perceived in the electronic waybill for those engaged in trades where the goods will change hands several times between shipment and discharge.  The privity of contract problems is therefore solved.

 

In practice most if not all of the problems identified can now be dealt with by contractual provision using the technological capacity of some of the new systems available on the market which provide sure and certain messaging links between shore based shippers and receivers and even the smallest carrier.  The contractual privity as between the carrier and whoever has taken a transfer (using the encrypted key mechanism) of the rights and obligations of the original holder can now be securely achieved without the need for any further legislation other than that already in place under the Electronic Communications Act 2000.

 

The right of disposal issue can be dealt with by similar contractual provision ensuring that a right of control and transfer in the event of non-payment is reserved.  Some of the big box carriers have agreed that such clauses could be used on their seawaybills to satisfy the needs of the trade and its bankers.  A system which is, moreover intrinsically linked to a documentary credit whereby the right of control and transfer will only pass on actual payment being made would fully answer that particular problem.

 

CCEWEB’s @Globaltrade system which closely interweaves these two principles is one example of precisely how the old CMI dilemma can be overcome without resorting to a closed system by providing that the right of control and disposal over the goods is vested solely in the purchaser/new holder upon payment and transfer. 

 

Reservation of Title

 

The passing of property question again requires contractual provision to be made but variations to the normal legal presumptions on transfer of title and property have long been a feature of international trade transactions since reservation of title clauses first made their appearance in the English courts.

 

Standardisation of both contract of carriage documentation and International Sale of Goods contractual documentation will accelerate the use of the dematerialised shipping documents.  The main trade associations are already approaching this task with a sense of purpose.  The real challenge facing the market is to ensure that all of this is done in a way which ensures an open system whereby there can be not only continued participation by all of those who currently engage in trade but at the same time to ensure that trading on the Internet not only moves forward in a secure and safe way but genuinely introduces a wider group of participants to international trade. 

 

Future Legislation

 

Naturally, legislative intervention would greatly enhance the introduction of electronic bills of lading but despite the deadlines imposed by the EU Electronic Commerce Directive for amending legislation to be brought in member states within the next 12 months it seems too much to hope for that amendments to the Carriage of Goods by Sea Act 1992, the Bills of Exchange Act and other legislation which specifically require documents to be “in writing” to be described variously as bills of lading or bills of exchange will actually come to fruition.  Some 40,000 separate references in English legislation to the words “in writing” have to be worked through one by one.  The present position is that electronic signatures can at least be used in evidence to prove that they were sent by the person who sent them with the content and the intent to convey that content but that does not make the electronic message one which is “in writing” for the purpose of the existing legislative definition.  Whether the banking world will embrace an electronic bill of exchange without seeing the comfort of legislation remains to be seen.

 

The banker’s security

 

Looking at all of this from a banker’s perspective how encouraged will he be to lend money. 

 

The starting point, it has to be said, is that bills of lading, particularly in fast moving short sea voyage transactions such as the oil trade long ago ceased to provide the bank with any real control over the goods against which they were nominally lending the money.  Those familiar with the Metro litigation will appreciate that once physical control over the goods is lost issues of title and security can be a nightmare.  Banks have principally taken to lending more and more on a balance sheet basis partly as they seek to lend at a higher level up the food chain to larger trading companies and partly because of the bother and expense of policing transactions which rely solely or heavily on transactional paperwork with its vulnerability to fraud and mishap.

 

When the Carriage of Goods by Sea Act 1992 was being enacted one of the concerns of the Law Commission which advised on the draft bill was that allowing any party (whether a receiver of goods or a bank) to come into possession of a bill of lading long after the goods had been discharged from the vessel and into the hands of the receiver and then pursue a claim against the carrier based on that bill of lading would be to encourage trafficking in legal causes of action.  Section 2 (2) of the Carriage of Goods by Sea Act 1992, therefore, provides that the right to sue the carrier will cease on delivery unless the bill of lading either passed into the hands of the holder prior to delivery (to the person entitled to delivery) of the goods at discharge or passed into his hands pursuant to a contractual arrangement entered into before that time. 

 

It is nevertheless a continuing feature of a number of trades that banks find themselves coming into possession of bills of lading in circumstances where the goods are discharged without the bills of lading and it is almost certain that they will have to look to the carrier in default of repayment by their customer and that the carrier will in turn be looking to whoever (often a bank) has provided him with a letter of indemnity.

 

Since modern cryptology techniques and the products available from the growing band of certification authorities will now allow messages and the authorisation of those messages to require confirmations and releases to be added by any number of authorised individuals within an organisation or, in the case of banks lending on transactions, from a second organisation, the banks will in practice be able to enjoy a greater degree of control over the transactions which they finance than they have at present.  So the answer to the question “how safe” will be “safer than it was”.  If banks were to seek to exercise the same degree of direct control over the traditional documentation in a flow of paperwork which has to go through 5 hands during the course of one short sea voyage their involvement would almost inevitably mean that documents would not be passed on within the contractual time limits and that indemnities would be given at the discharge port.  With the time delays in handling the electronic version of the same documents truncated to matters of minutes and hours rather than days, there is no reason at all why banks cannot look again at the viability of dealing with transactional work which they have more recently avoided and to derive the extra security from the shipping documents which now often give them no more than a right of action against a carrier and often in circumstances where they have to pursue the carrier to a second or third port before securing their claim.

 

Non-delivery/misdelivery

 

The shortcoming of the original CMI model in failing to provide a clear right against the carrier from the ultimate receiver can now be overcome by means of direct contractual provision.  The carrier will undertake to the bank through a control and disposal clause that it will not deliver to anyone other than a party which the carrier has been authorised to deliver to through the endorsement of the electronic message with the appropriate encrypted authority.  The @GlobalTrade shipping document will employ this model. What is being passed on each time to the next holder of the key is a contractual right against the carrier not a right against the original Seller of the transaction or the shipper.  Although any other rights under the contract of sale between the Buyer and Seller would be dealt with in the normal way.

 

System breakdown

 

One of the issues that has weighed heavily on all those organisations drafting rules to be applied to Internet based contractual relationships is what happens when the machinery processing the electronic data breaks down.  Both the putative URGETS rules which have now gone back to the relevant ICC committee for the second time of asking and the well advanced draft eUCP rules which will provide an electronic interpretation tool for electronic credits under UCP 500 have adopted a similar approach which is to provide that in the event of breakdown of an information system into which a message is directed the time for completing acts and tasks under the different contractual rules will be extended until the next banking or business day on which system is reactivated. 

 

The future – eUCP - how will it benefit bankers and traders?

 

Looking at the developments in eUCP which is due to come into effect in June 2002 (or earlier if approved at an earlier stage by the banking commission and executive board of the ICC) this is already focusing on some of the issues which will make a real difference to the timing and security of electronic documentary credit transactions. 

 

Some of the “sacred cows” of UCP 500 have been taken on by the ICC’s working group on electronic credits and among those is the shortening of the maximum time for examination of a purely electronic presentation of documents under an electronic credit.  No final decision has been made on this but a shortening from 7 to 5 days for the maximum time for an electronic presentation would certainly go along with the frequent comments of judges in the English courts who have stressed that the requirement is to inspect documents and deal with rejection and/or discrepancies without delay and no later than the seventh day.  Too many banks, in circumstances where they could clearly have come to a view within 24 to 48 hours continue to utilise that period within which to bounce discrepancy issues off their customers. 

 

Other draft provisions would include tackling how concepts of “appearance” of documents are dealt with electronically so that for example the term “appears on its face” will apply to the data content of an electronic record and “authenticate” will mean verifying the identity of the sender and the integrity of the information and electronic record.  Likewise “place for presentation” would be defined as the electronic address.

 

Presentation of documents will for the foreseeable future include both electronic and paper documents and this is provided for in the draft provisions.  Not everyone will be in a position to go electronic in a short space of time.  There will also be a provision that a notice will be served by the beneficiary at a stage where it considers it has submitted the last piece of electronic or paper information to complete its paper/electronic presentation.  The two presentations are likely to be difficult to precisely coincide.

 

Electronic records will be deemed to be “original” unless stated otherwise and references to multiple copies will be satisfied by one electronic record.  Those of us closely involved in developing these systems and the contractual provisions which will cover the ground I have described above have to ensure that the peripheral services and agencies which currently collect those multiple copies are mapped into the system to receive the information electronically.

 

Provisions will also be in place to provide a default date to apply for the effective date of documents which will in general be the date when the electronic document is issued unless it states otherwise. 

 

Conclusion

 

The framework both in terms of international convention/rules and commercial enterprise is swiftly coming into place to allow secure trade finance over the Internet to become a reality.  Much depends of course on the extent to which the certification authorities which will provide the underlying security for the messaging systems succeed in satisfying the concerns of traders and bankers alike as to how their information and their secure identities will be preserved.  There is a challenge here too for government.  Whilst the non-mandatory provisions of the Electronic Communications Act 2000 do allow government to set “kite mark” standards for certification authorities they have so far refrained from taking any steps towards this and sooner or later that particular nettle will have to be grasped.