DRAFT #32

 

Commentary for UN Convention on International Independent Guarantees and

Standby Letters of Credit

 

 

This Commentary deals with apparent inconsistencies between the Convention and Article 5 of the Uniform Commercial Code.  This Commentary has been prepared by a Committee made up of representatives of the Uniform Law Commission and the American Law Institute and Canadian and Mexican letter of credit experts who are involved with the consideration of the Convention in their respective countries.

 

Since the Convention is short and quite general, it does not deal with many topics covered in Article 5 of the UCC or in the Uniform Customs and Practices (UCP) or the International Standby Practices (ISP 98). When a standby letter of credit or an independent guarantee (“undertaking”) incorporates one of the trade practice documents (such as ISP 98 or UCP 600), the trade practice so incorporated will fill any omission that is left by the Convention if the trade practice covers the omission, and, in other cases, the adoption of trade practice will vary the Convention’s rules. Paragraph 5 of the Secretariat’s Commentary to the Convention it recognizes that the Convention “gives legislative support to the autonomy of the parties to apply agreed rules of practice such as the [UCP].” In some cases no practice will be incorporated by the undertaking and in others the incorporated practice will have no provision relevant to the matter at issue; when that is so the Commentary below generally directs one to “other law.” For U.S. parties other law might be the applicable rules of contract or they mightwould usually be Article 5 of the Uniform Commercial Code.

 

Some of the omissions from the Convention arise from the drafters’ recognition that certain issues are inherently domestic; other omissions recognize the existence and validity of certain national rules.  Because many of the omissions represent an intention to defer to domestic rules that vary from state to state, courts should turn to domestic law and cases to fill in the omissions, not to international law and cases.

 

Notwithstanding the differing terminology, the rules in the Convention are generally consistent with those in Article 5 of the UCC.  Because of this congruence between Article 5 and the Convention and because it is easy to opt out of all or any part of the Convention, the adoption of the Convention by the United States will cause little change in American law.

 

The following commentary is divided according to the Articles of the Convention:

 

Article 1.  Scope of Application

 

(1) This Convention applies to an international undertaking referred to in article 2:

(a)    If the place of business of the guarantor/issuer at which the undertaking is issued is in a Contracting State, or

(b)    If the rules of private international law lead to the application of the law of a Contracting State,

unless the undertaking excludes the application of the Convention.

 

(2) This Convention applies also to an international letter of credit not falling within article 2 if it expressly states that it is subject to this Convention.

 

(3) The provisions of articles 21 and 22 apply to international undertakings referred to in article 2 independently of paragraph (1) of this article.

 

An undertaking’s incorporation of the UCP or ISP is not the adoption of “other law” as that term is used above, is used in Article 1 [Jim, I did not see where Article 1 used the term “other law”], but such incorporation might add terms and might otherwise change the rule that would prevail under the Convention but for the incorporation.

 

A letter of credit that is states that it is “subject to the law of New York” is governed by New York’s version of Article 5 of the UCC, not by the Convention.  That is so despite the fact that New York law might be thought to include the Convention because of the Convention’s adoption by Congress. Even after the adoption of the Convention, American banks’ and American lawyers’ familiarity with and use of Article 5 of the UCC would lead then to regard Article 5 as the “law” of any particular state.  Where parties so adopt the law of a particular state, there is no need specifically to exclude the Convention  [Jim, I found this paragraph to be confusing.  If the U.S. were a Contracting State, the law of New York would include the Convention, no?  That seems be the learning coming out of the CISG.  Wouldn’t the letter of credit have to say that is subject to Article 5 of the UCC in order to vary a variable provision of the Convention that conflicts with Article 5?]

 

To understand the relationship between Article 1 and Articles 21 and 22 consider the following example. Assume that Canada has adopted the Convention and that litigation arises in a Canadian court involving a standby letter of credit that chooses English law to govern the rights of a Canadian Issuer, Canadian Applicant and an English beneficiary. In that case the Canadian court should apply English law as directed by Article 21 of the Convention. Even though the Convention would not govern the substantive rights of the parties, it would provide the choice of law rule that the Canadian court should follow.

 

Article 2.  Undertaking

 

(1) For the purposes of this Convention, an undertaking is an independent commitment, known in international practice as an independent guarantee or as a stand-by letter of credit, given by a bank or other institution or person ("guarantor/issuer") to pay to the beneficiary a certain or determinable amount upon simple demand or upon demand accompanied by other documents, in conformity with the terms and any documentary conditions of the undertaking, indicating, or from which it is to be inferred, that payment is due because of a default in the performance of an obligation, or because of another contingency, or for money borrowed or advanced, or on account of any mature indebtedness undertaken by the principal/applicant or another person.

 

(2) The undertaking may be given:

(a)    At the request or on the instruction of the customer ("principal/applicant") of the guarantor/issuer;

(b)    On the instruction of another bank, institution or person ("instructing party") that acts at the request of the customer ("principal/applicant") of that instructing party; or

(c)     On behalf of the guarantor/issuer itself.

 

(3) Payment may be stipulated in the undertaking to be made in any form, including:

(a)    Payment in a specified currency or unit of account;

(b)    Acceptance of a bill of exchange (draft);

(c)     Payment on a deferred basis;

(d)    Supply of a specified item of value.

 

(4) The undertaking may stipulate that the guarantor/issuer itself is the beneficiary when acting in favour of another person.

 

Undertakings brought within the Convention include 1) standby letters that require the presentation of only a demand (“clean” letters of credit) and 2) letters of credit known as “direct pay” letters, see paragraph 8 of the Secretariat’s commentary, but do not include commercial letters of credit, except for commercial letters that expressly state that they are covered.

 

The limitation in Article 2 to undertakings that require payment upon presentation of a “demand,” possibly accompanied with “documents,” is the same as the limitation imposed in Article 5 of the UCC by Sections 5-102(a) (10) and 5-103(d). That an issuer not be burdened with the duty of a conventional guarantor – to make an independent investigation of default – is a critical distinction between letters of credit and independent guarantees on the one hand and dependent or conventional guarantees on the other. Paragraph 9 of the Secretariat’s Commentary similarly states that the “guarantor/issuer is not called on to investigate the underlying transaction, but is merely to determine whether the documentary demand for payment conforms on its face to the terms of the guarantee or stand-by letter of credit.”

 

Article 3.  Independence of Undertaking

 

(1) For the purposes of this Convention, an undertaking is independent where the guarantor/issuer’s obligation to the beneficiary is not:

(a)  Dependent upon the existence or validity of any underlying transaction, or upon any other undertaking (including stand-by letters of credit or independent guarantees to which confirmations or counter-guarantees relate); or

(b)  Subject to any term or condition not appearing in the undertaking, or to any future, uncertain act or event except presentation of documents or another such act or event within a guarantor/issuer’s sphere of operations.

 

Certain fundamental nondocumentary conditions in a writing purporting to be a letter of credit or an independent guarantee would deprive the document of that status and so remove it from the coverage of the Convention. If, for example, a document required the issuer to pay upon issuer’s determination that a person had defaulted (not on a documentary certification of default), the document would be a contract but not a letter of credit or independent guarantee subject to the Convention.  On the other hand, the presence of a less fundamental nondocumentary condition (e.g. issuer shall pay on a decision from a “duly appointed arbitrator”) would not deprive the document of its status as a letter of credit.  In the latter case the issuer should disregard the nondocumentary condition, see e.g., Section 5-108(g) of the UCC.

 

Article 6.  Definitions

 

For the purposes of this Convention and unless otherwise indicated in a provision of this Convention or required by the context:

 

(a)    "Undertaking" includes "counter-guarantee" and "confirmation of an undertaking";

(b)    "Guarantor/issuer" includes "counter-guarantor" and "confirmer";

(c)     "Counter-guarantee" means an undertaking given to the guarantor/issuer of another undertaking by its instructing party and providing for payment upon simple demand or upon demand accompanied by other documents, in conformity with the terms and any documentary conditions of the undertaking, indicating, or from which it is to be inferred, that payment under that other undertaking has been demanded from, or made by, the person issuing that other undertaking;

(d)    "Counter-guarantor" means the person issuing a counter-guarantee;

(e)     "Confirmation" of an undertaking means an undertaking added to that of the guarantor/issuer, and authorized by the guarantor/issuer, providing the beneficiary with the option of demanding payment from the confirmer instead of from the guarantor/issuer, upon simple demand or upon demand accompanied by other documents, in conformity with the terms and any documentary conditions of the confirmed undertaking, without prejudice to the beneficiary's right to demand payment from the guarantor/issuer;

(f)      "Confirmer" means the person adding a confirmation to an undertaking;

(g)    "Document" means a communication made in a form that provides a complete record thereof.

 

That “Document” is defined broadly enough to include digital documents does not by itself authorize one who is making presentment under the Convention to present documents in non-paper form. Thus where there is no authority in the undertaking or in the relevant practice incorporated in or applicable to the undertaking to authorize the use of a digital document, the presentation of a digital document would render the presentation non complying both under the Convention and under Article 5 of the UCC.

 

Article 8.  Amendment

 

(1) An undertaking may not be amended except in the form stipulated in the undertaking or, failing such stipulation, in a form referred to in paragraph (2) of article 7.

 

(2) Unless otherwise stipulated in the undertaking or elsewhere agreed by the guarantor/issuer and the beneficiary, an undertaking is amended upon issuance of the amendment if the amendment has previously been authorized by the beneficiary.

 

(3) Unless otherwise stipulated in the undertaking or elsewhere agreed by the guarantor/issuer and the beneficiary, where any amendment has not previously been authorized by the beneficiary, the undertaking is amended only when the guarantor/issuer receives a notice of acceptance of the amendment by the beneficiary in a form referred to in paragraph (2) of article 7.

 

(4) An amendment of an undertaking has no effect on the rights and obligations of the principal/ applicant (or an instructing party) or of a confirmer of the undertaking unless such person consents to the amendment.

 

Article 8 does not exclude the possibility that a party’s rights under the Convention may be altered by implication. For example, both the UCC and rules of practice contemplate would find that a beneficiary’s presentation under and in conformity with anan amended letter of creditundertaking that invokes the amended terms of the undertaking may constitutes the beneficiary’s agreement to the amendment. See Section 5-106, comment 2, UCP Article 10c and ISP98 section 2.06c.ii. Article 8 is not different.

 

Article 10.  Assignment of Proceeds

 

(1) Unless otherwise stipulated in the undertaking or elsewhere agreed by the guarantor/issuer and the beneficiary, the beneficiary may assign to another person any proceeds to which it may be, or may become, entitled under the undertaking.

 

(2) If the guarantor/issuer or another person obliged to effect payment has received a notice originating from the beneficiary, in a form referred to in paragraph (2) of article 7, of the beneficiary's irrevocable assignment, payment to the assignee discharges the obligor, to the extent of its payment, from its liability under the undertaking.

 

The statement in paragraph (2) that an issuer’s payment to an assignee would, in the circumstances there stated, lead to the discharge of its obligation to pay, does not determine whether the issuer would have an obligation to pay nor does it determine whether payment to the assignor in similar circumstances would discharge any obligation it might have under the undertaking. Those matters are left to domestic letter of credit law and to rules such as ISP98 Rule 6.06 ff.

 

Article 11.  Cessation of Right to Demand Payment

 

(1) The right of the beneficiary to demand payment under the undertaking ceases when:

(a)    The guarantor/issuer has received a statement by the beneficiary of release from liability in a form referred to in paragraph (2) of article 7;

(b)    The beneficiary and the guarantor/issuer have agreed on the termination of the undertaking in the form stipulated in the undertaking or, failing such stipulation, in a form referred to in paragraph (2) of article 7;

(c)     The amount available under the undertaking has been paid, unless the undertaking provides for the automatic renewal or for an automatic increase of the amount available or otherwise provides for continuation of the undertaking;

(d)    The validity period of the undertaking expires in accordance with the provisions of article 12.

 

(2) The undertaking may stipulate, or the guarantor/issuer and the beneficiary may agree elsewhere, that return of the document embodying the undertaking to the guarantor/issuer, or a procedure functionally equivalent to the return of the document in the case of the issuance of the undertaking in non-paper form, is required for the cessation of the right to demand payment, either alone or in conjunction with one of the events referred to in subparagraphs (a) and (b) of paragraph (1) of this article. However, in no case shall retention of any such document by the beneficiary after the right to demand payment ceases in accordance with subparagraph (c) or (d) of paragraph (1) of this article preserve any rights of the beneficiary under the undertaking.

 

The last sentence is consistent with Article 5 of the UCC, as stated in Paragraph 34 of the Secretariat’s Commentary.

 

Article 12.  Expiry

 

The validity period of the undertaking expires:

(a)    At the expiry date, which may be a specified calendar date or the last day of a fixed period of time stipulated in the undertaking, provided that, if the expiry date is not a business day at the place of business of the guarantor/issuer at which the undertaking is issued, or of another person or at another place stipulated in the undertaking for presentation of the demand for payment, expiry occurs on the first business day which follows;

(b)    If expiry depends according to the undertaking on the occurrence of an act or event not within the guarantor/issuer's sphere of operations, when the guarantor/issuer is advised that the act or event has occurred by presentation of the document specified for that purpose in the undertaking or, if no such document is specified, of a certification by the beneficiary of the occurrence of the act or event;

(c)     If the undertaking does not state an expiry date, or if the act or event on which expiry is stated to depend has not yet been established by presentation of the required document and an expiry date has not been stated in addition, when six years have elapsed from the date of issuance of the undertaking.

 

Neither the Convention nor UCC Section 5-106 permits an undertaking to operate in perpetuity, but the time periods differ.  Under Section 5-106 letters claiming that claim to be perpetual expire after 5 years and those without an expirationa date expire after 1 year; under the Convention all undertakings without fixed expiration dates expire in 6 years.

 

The rule on undertakings without expiration dates does not affect undertakings that contain automatic extension clauses even though such undertakings may state no final expiration date. In those cases the undertaking is to be terminated by payment or by the issuer’s giving notice that it will not extend the undertaking.

 

Article 14.  Standard of Conduct and Liability of Guarantor/issuer

 

(1) In discharging its obligations under the undertaking and this Convention, the guarantor/issuer shall act in good faith and exercise reasonable care having due regard to generally accepted standards of international practice of independent guarantees or stand-by letters of credit.

 

(2) A guarantor/issuer may not be exempted from liability for its failure to act in good faith or for any grossly negligent conduct.

 

Despite the explicit reference to good faith and to reasonable care, the standard of conduct stated in this Article is consistent with the standard stated in Section 5-108. Note that Article 1 of the UCC the UCCimposes a duty of good faith is imposed on the issuer’s duties responsibilities in Section 5-108 by Section 1-304. Exercise of “reasonable care” would not be a defense under Article 14, 15 and 17 for an issuer who dishonored a presentation that strictly complied (absent fraud or the circumstances stated in Article 19) or for an issuer who honored a presentation that did not strictly conform.

 

Observance of the relevant standard practice constitutes the exercise of reasonable care. Paragraph 38 of the Secretariat’s Commentary similarly states that the standard of conduct “is to be defined by reference to generally accepted standards of international practice.” However, it also explains that Article 14(2) “prohibits any exemption of the guarantor from liability for a lack of good faith or gross negligence.”

 

Article 15.  Demand

 

(1) Any demand for payment under the undertaking shall be made in a form referred to in paragraph (2) of article 7 and in conformity with the terms and conditions of the undertaking.

 

(2) Unless otherwise stipulated in the undertaking, the demand and any certification or other document required by the undertaking shall be presented, within the time that a demand for payment may be made, to the guarantor/issuer at the place where the undertaking was issued.

 

(3) The beneficiary, when demanding payment, is deemed to certify that the demand is not in bad faith and that none of the elements referred to in subparagraphs (a), (b) and (c) of paragraph (1) of article 19 are present.

 

Consistent with Section 5-110, a false or inaccurate certification under paragraph 3 does not justify dishonor. (Of course, the beneficiary’s fraudulent behavior might give the issuer a right to dishonor under Article 19.) Whether the beneficiary’s giving of a false or inaccurate certification gives a claim for damages or other remedy and to whom is left to other law such as Section 5-110, cf. Paragraph 40 of the Secretariat’s Commentary

 

Paragraph 2’s requirement that one present to the “guarantor/issuer” does not apply to undertakings that allow presentation to a nominee or confirmer and does not override normal letter of credit practice that might allow for presentation to a nominated bank or to a confirmer see e.g., UCP600 and ISP98.

 

Article 16.  Examination of Demand and Accompanying Documents

 

(1) The guarantor/issuer shall examine the demand and any accompanying documents in accordance with the standard of conduct referred to in paragraph (1) of article 14. In determining whether documents are in facial conformity with the terms and conditions of the undertaking, and are consistent with one another, the guarantor/issuer shall have due regard to the applicable international standard of independent guarantee or stand-by letter of credit practice.

 

(2) Unless otherwise stipulated in the undertaking or elsewhere agreed by the guarantor/issuer and the beneficiary, the guarantor/issuer shall have reasonable time, but not more than seven business days following the day of receipt of the demand and any accompanying documents, in which to:

(a)    Examine the demand and any accompanying documents;

(b)    Decide whether or not to pay;

(c)     If the decision is not to pay, issue notice thereof to the beneficiary.

 

The notice referred to in subparagraph (c) above shall, unless otherwise stipulated in the undertaking or elsewhere agreed by the guarantor/issuer and the beneficiary, be made by teletransmission or, if that is not possible, by other expeditious means and indicate the reason for the decision not to pay.

 

Whether documents are consistent with one another has to be judged by the applicable international practice that might be incorporated in the undertaking. For example UCP500 Article 13a required that documents not be “inconsistent” with one another; UCP600 Article 14d requires that they not “conflict,” and ISP Rule 4.03 provides that one must “examine” for “inconsistency” only to the extend that the undertaking requires 98 and Article 5 of the UCC hasve no analogous requirement.

 

Article 16 does not specify the consequences of an issuer’s failure to give notice or to give its reasons for dishonor in the notice.  Where an undertaking under the Convention is not subject to law or rules of practice that provide for timely and adequate notice of refusal and where such law or practice does not spell out the consequence of failure to give such notice, a court may apply UCC Section 5-108(c) or rules of practice such as UCP600 Article 16 or ISP98 Rule 5.03 and so preclude the issuer from using any unstated reasons to justify its dishonor.

 

Article 17.  Payment

 

(1) Subject to article 19, the guarantor/issuer shall pay against a demand made in accordance with the provisions of article 15. Following a determination that a demand for payment so conforms, payment shall be made promptly, unless the undertaking stipulates payment on a deferred basis, in which case payment shall be made at the stipulated time.

 

(2) Any payment against a demand that is not in accordance with the provisions of article 15 does not prejudice the rights of the principal/applicant.

 

Article 17(2) does not establish or address any rights that the principal or applicant may have after a payment that may violate Article 15.  Those rights must be found in the agreements of the parties or in the rules of practice.

 

Article 19.  Exception to Payment Obligation

 

(1) If it is manifest and clear that:

(a)    Any document is not genuine or has been falsified;

(b)    No payment is due on the basis asserted in the demand and the supporting documents; or

(c)     Judging by the type and purpose of the undertaking, the demand has no conceivable basis, the guarantor/issuer, acting in good faith, has a right, as against the beneficiary, to withhold payment.

 

(2) For the purposes of subparagraph (c) of paragraph (1) of this article, the following are types of situations in which a demand has no conceivable basis:

(a)    The contingency or risk against which the undertaking was designed to secure the beneficiary has undoubtedly not materialized;

(b)    The underlying obligation of the principal/applicant has been declared invalid by a court or arbitral tribunal, unless the undertaking indicates that such contingency falls within the risk to be covered by the undertaking;

(c)     The underlying obligation has undoubtedly been fulfilled to the satisfaction of the beneficiary;

(d)    Fulfillment of the underlying obligation has clearly been prevented by willful misconduct of the beneficiary;

(e)     In the case of a demand under a counter-guarantee, the beneficiary of the counter-guarantee has made payment in bad faith as guarantor/issuer of the undertaking to which the counter-guarantee relates.

 

(3) In the circumstances set out in subparagraphs (a), (b) and (c) of paragraph (1) of this article, the principal/applicant is entitled to provisional court measures in accordance with article 20.

 

The effect of Article 19 against the beneficiary is substantially the same as the fraud rule stated in Section 5-109(a). Paragraph 46 of the Secretariat’s Commentary states that the purpose of Article 19 is to provide an “internationally agreed general definition of the types of situations in which an exception to the obligation to pay against a facially compliant demand would be justified,” and that the “definition encompasses fact patterns covered in different legal systems by notions such as ‘fraud’ or ‘abuse of right.’”

 

Since Article 19 is silent as to the rights of the issuer against other parties, such as holders in due course, a court may choose to apply Section 5-109 where there are claims by or against such persons.

 

Article 20.  Provisional Court Measures

 

(1) Where, on an application by the principal/applicant or the instructing party, it is shown that there is a high probability that, with regard to a demand made, or expected to be made, by the beneficiary, one of the circumstances referred to in subparagraphs (a), (b), (c) or paragraph (1) of article 19 is present, the court, on the basis of immediately available strong evidence, may:

(a)  Issue a provisional order to the effect that the beneficiary does not receive payment, including an order that the guarantor/issuer hold the amount of the undertaking, or

(b)  Issue a provisional order to the effect that the proceeds of the undertaking paid to the beneficiary are blocked, taking into account whether in the absence of such an order the principal/applicant would be likely to suffer serious harm.

 

(2) The court, when issuing a provisional order referred to in paragraph (1) of this article, may require the person applying therefor to furnish such form of security as the court deems appropriate.

 

(3) The court may not issue a provisional order of the kind referred to in paragraph (1)of this article based on any objection to payment other than those referred to in subparagraphs (a), (b), (c) of paragraph (1) of article 19, or use of the undertaking for a criminal purpose.

 

Because the Convention does not include a full range of procedural rules, courts that deal with extraordinary remedies should use local procedural rules and may invoke local rights and remedies to supplement those in Article 20.