Universidad de los Andes
Standby Letters of Credit’s Applicable Law in the Colombian Legal System
I. INTRODUCTION
The research process began on behalf of a controversy, in which the decision will provide the applicable law of a standby letter of credit in Colombia. One submission argues that the applicable law is the Colombian, but uniform international regulations, such as the ISP 98 and the UCP 600 are also applicable, as long as there’s a clause in the letter that incorporates them. The other submission states that these international regulations are not applicable law, because they contradict Colombian public policy rules regarding suretyship regulations (fianza).
In order to clear this controversy, the research question that would guide this issue is the following ¿According to the Colombian legal system, it’s valid to incorporate international uniform regulations to a standby letter of credit in a local transaction?
Before moving on to the substance, is necessary to understand the terminology used in the different legal systems. This necessity arises from the fact that banking practices have become multinational and tend to uniformity, but terminology differs from continental and common law. The entire area of guarantees is marked by confusion. The actual independent guarantee emerged from practice, but it was unknown by the law. The traditional personal security which is accessory to the main obligation was usually known as “suretyship”, but in the banking practice this “suretyship” was also indistinctly known as guarantee; hence the confusion (Bertramps, 2004, pág. 4). On continental law, the written and case law separate the concepts of accessory suretyship and independent guarantees. Nevertheless, this is an abstract difference that in practice provides almost no aid. Bankers and lawyers are worried about how these instruments become effective; do they have to fully proof the default, or submit documentation provided by third parties, or submit documentation provided by themselves. The classification between accessory suretyships and independent
guarantees it’s not important, and they are used indistinctly in practice (Bertramps, 2004, pág. 200).
On common law, the terms covering the two regarded concepts are the following: “the guarantee (or guaranty) being the accessory type of security and the standby letter of credit being the independent type of security. (…) The extent of co-extensiveness or independence
and the rights and obligations of parties can only be derived from the particular terms and conditions of the bond.” (Bertramps, 2004, pág. 200). Therefore, if one must determine
whether a security is independent or accessory, the terminology provided in the letter or contract is not enough; one must analyze the terms and conditions of the bond.
The common law term “standby letter of credit” is equivalent to the continental law term “independent guarantee” (Bertramps, 2004, pág. 4). The standby LC originated in the USA. Under the National Bank Act of June 3rd, 1864, the banks where not authorized to answer for debts of others. Guarantees issuance was an activity authorized solely to insurance and bonding companies. In order to dodge this prohibition, American Banks issued bills of exchange and letters of credit (which fell under their authorized transactions), which in appearance where not guarantees, but in substance they fulfilled the guaranteeing purpose. “This practice became gradually well-established and remained largely unopposed.” (Bertramps, 2004, pág. 6). As this practice established, the following question arose: what kind of guarantees can banks issue? It was still a believe that banks could not issue this type of securities, because they would have to engage into an investigation regarding the default of the principal and secondary debtor, activity they were not qualified or prepared to do. This problem was solved when the banks liability was to be determined “solely by reference to the terms of its undertaking to pay, in particular where the tender of certain documents was the event triggering the payment without reference to the terms of the underlying transaction, and if the decision to issue the undertaking depend on the usual investigation of the account party’s creditworthiness.” (Bertramps, 2004, pág. 6). The
final revised Interpretative Ruling 7.1016 of the Comptroller of the Currency of 9 February 1996. (Bertramps, 2004, pág. 6).
From now on, the traditional letters of credit will refer to means of payment in sale transactions, and “standby letters of credit” will refer to a security for default, which has an independent and documentary nature (Bertramps, 2004, pág. 6). This terminology has been used in Latin American and Far East countries which have American banking practices1. Therefore, American standby LC´s are equivalent to continental law independent guarantees.
After explaining the history and terminology of the guarantees, it´s necessary to explain the Colombian case. Historically, guarantees had been categorized as personal and in rem (Ustáriz González, 2004, pág. 7). As commerce have become complex, new categories appeared: “(i) Personal, where we found the security and the co-signature; (ii) Exchange, through the credit incorporation in instruments such as the bill of exchange and the promissory note; (iii) Mortgage, constituted on real estate, ships and planes; and (iv) Collateral, which relates to the pledge on securities or movable assets.” (Ustáriz González,
2004, pág. 7).
The guarantee instruments adopted a wide variety of categories, such as: bank guarantees, parent company guarantees, letters of awareness, on first demand guarantees and Standby Letters of Credit (Ustáriz González, 2004, págs. 7-10). Before focusing on the last instrument, a short definition of the other instruments will be provided.
Bank guarantees are the ones issued by a financial institution, such as the bank endorsement. These instruments, although categorized as bank guarantees, have the particular characteristic of being securities. The endorsement guarantees seek the settlement of an exchange obligation, incorporated in the security, providing confidence to the new owners of it. The guaranteeing’s obligation is independent from the one of the guaranteed,
1
and is in the same degree (direct or in return). Therefore, the holder of the title can require payment interchangeably to any of the signatories, even to the guaranteeing. Even further, if the obligation of the guaranteed is invalid, the one of the guaranteeing is not affected by this, and subsists (Ustáriz González, 2004, pág. 8).
Parent company guarantees are the ones issued by the parent company of a subordinated, which secure that, in case the subordinated breaches its obligations, the parent company will fulfill them. Normally, they are issued by multinational companies, which are ruled by foreign laws. These guarantees are effective only if they follow the foreign legal system (Ustáriz González, 2004).
Letters of awareness are issued as a written statement addressed to the credit institution, or to any other subject, that supports the financing obtainment or the negotiating process, from a subordinated society. As such, they are not bank guarantees, because is the bank the one that would receive the statement. These letters are classified as following: i) merely declaratory clause; ii) maintaining shareholding clause; iii) subordinated control clause; iv) financial support clause (Ustáriz González, 2004, págs. 9-10).
Unlike continental law guarantees, which are accessory of the main obligation, on first demand guarantees are independent from it. Hence, under these modern instruments the financial institutions become guaranteeing instead of being guaranteed, and the guarantee is independent from the main obligation. Once issued, these types of guarantees become a different obligation between the bank and the beneficiary, hence the bank does not fulfill the obligation on behalf of the debtor, but it bonds primarily in return for a lump sum, known as a commission. They also differ from the security (fianza), because in the security the guarantor’s obligation becomes effective if the main debtor breaches the guaranteed obligation (Ustáriz González, 2004).
Letters of credit are very important commerce instruments around the world. Now a day, many of the most important transactions are guaranteed with these types of letters. (Sifri, 2008, pág. xiii).Their main objective is to transfer the contract risk from one party to another in a credit transaction. Concerning the standby letters of credit, they take the form of an obligation compliance assurance, becoming effective whenever the guaranteed obligation is unfulfilled. (Maximiliano Rodriguez Fernández & Arias Barrera , 2009, pág. 23) (Dole Jr., 2002, pág. 381). It is granted by a bank on demand of the seller in favor of the buyer of the merchandises (payee), and it becomes effective with the submission of a document that certifies the buyer’s unfulfilled obligation of delivering the merchandises. Its purpose, rather than to ensure payment to the seller, it’s an insurance of the seller performance (Folson, Wallace, & Spanogle, Jr., 2005, pág. 158).
Standby letters and regular letters of credit are ruled by the same substantive laws and practice. Nevertheless, they have several differences. The main difference lies in the documents that must be submitted. In the regular LC, in order for it to become effective, one must submit documents that show the beneficiary has performed the obligation. In a standby LC, in order for it to become effective, one must submit documents that show that the principal has failed to perform (Folson, Wallace, & Spanogle, Jr., 2005, pág. 159).
“The standby letter of credit is primarily a risk-shifting device, with the advantage of providing the beneficiary with swift and easy access to funds in case of a default by the costumer, much as if the costumer had left a cash deposit with the beneficiary.” (Folson,
Wallace, & Spanogle, Jr., 2005).
In the standby LC, the beneficiary demands the payment only when the customer doesn´t fulfill the underlying obligation. In regular LC´s, the documentation required to demand the settlement is generated by a third party (bill of lading), while in standby LC´s, the
beneficiary generates all the documentation required2 (Folson, Wallace, & Spanogle, Jr., 2005, pág. 160).
Standby LC´s are riskier to a bank than the regular LC’s. In standby LC´s, the bank cannot verify or investigate the actual default of its costumer. It must pay on demand, just verifying the documents required. The only valid exception to a standby LC is fraud. Usually, standby LC´s are unfunded; this means that the settlement is not taken from the customer´s account, because the bank doesn´t expect to pay this letter. Therefore, the customer guarantees that the bank will be “reimbursed if it is forced to pay out the letter.” (Folson, Wallace, & Spanogle, Jr., 2005, pág. 160)
II. APLICABLE LAW
International regulation
Standby letters of credit are issued using two international regulations; the USP 600 and the ISP 98. UCP600 rules regulate commercial letters of credit. Nevertheless, most of the UCP provisions do not apply to standby letters of credit. (Sifri, 2008, pág. 3) On the other hand, “The ISP is a complete set of rules that represent the practice of international banks in handling standby LCs. It has been drafted by a group of experts and sanctioned by The International Chamber of Commerce (ICC); hence, it is globally recognized by all banks.” (Sifri, 2008, pág. 3).
UCP 600
“UCP 600 are the latest revision of the Uniform Customs and Practice that govern the operation of letters of credit. UCP 600 comes into effect on 01 July 2007. The 39 articles of UCP 600 are a comprehensive and practical working aid to bankers, lawyers, importers, and exporters, transport executives, educators, and everyone involved in letter of credit transactions worldwide.” (International Commerce Chamber, 2007). The UCP 600 was
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issued because under UCP 500, documents were usually rejected due to technical reasons. The International Commerce Chamber (ICC) reorganized the rules, wrote better definitions and interpretations and changed the rules for examination of submitted documents (Wood, 2008, pág. 105). The UCP 600 focuses on commercial LC’s, but it’s applicable to all sorts of letters of credit.
ISP98
Due to the fact that the ISP98 is “a complete set of rules that represent the practice of international banks in handling standby LCs” (Sifri, 2008, pág. 3); it will be broadly
studied, in order to identify all the characteristics that this instrument usually has. The first rule of the ISP98 (International Standby Practices) defines the scope, application, definitions, and Interpretation of the rest of provisions. (International Commerce Chamber, 1998). The ISP98 is intended to be applied to standby letters of credit, which include performance, financial, and direct pay standby LC´s, but can also apply to similar undertakings3. In Performance standby LCs, the petitioner has to fulfill a positive obligation, like the construction of a building. The financial standby requires from the applicant the payment of a lump sum. The Direct Pay Standby LCs bond the issuer to pay “principal, interest or both when a financial instrument becomes due or upon redemption. The default coverage is meant to protect against insolvencies of the issuer of the securities or the debt instrument.” (Sifri, 2008, pág. 10). These rules can only apply by express reference to them by the parties, incorporating it in the LC4. The parties may also exclude the application of certain rules of this regulation, by expressing it on the LC’s text5.
3
Article 1.01 a. ISP98 4
Article 1.01 b. ISP98 5
The relationship between the ISP98 and other rule sources is the following6: whenever the ISP98 contradicts commercial, banking, LCs or any other national laws, the national laws supersede the rules of the ISP98. Whenever the ISP98 contradict other rules of practice (like UCP 600), ISP98 provisions supersede. This prevailing rule is only applicable when referring to standby LCs. If the contradiction occurs under a commercial LC, the ISP98 provisions will not prevail.
The ISP98 is a Rule of Practice. This means that it represents the mercantile usage undertaken by International Banks in standby LCs transactions7 (Sifri, 2008, pág. 12). The ICC issued these rules in order to unify a trustworthy payment system that guarantees the rights of the parties involved in International commerce transactions. These rules were not issued by any country legal system, and must be understood and interpreted as commercial practice. This means that “the ISP98 must always be interpreted in the context of a reliable and liquid instrument used to avail immediate payment to the beneficiary upon presentation
of a simple demand without having to go beyond checking the demand sheet on its face to ensure that it complies with the standby terms and conditions.” (Sifri, 2008, pág. 12).
Hence, banks cannot dishonor their obligation to pay under national laws. They can only propose the exception of fraud under a court dispute. As the ISP98 rules are practices and terminology of banks and businesses in day-to-day transactions8, an interpretation from a legal perspective “would contradict their purpose and may create harmful complications.” (Sifri, 2008, pág. 12). Therefore, interpretation of these rules coming from the legal system of any country is not permitted9.
Whenever a standby LC is issued under ISP98 provisions, these rules will apply to all the parties that intervene in the transaction10. These parties include: “the issuer, the beneficiary to the extent it uses the standby, any advisor, any confirmer, any person nominated in the standby who acts or agrees to act, and the applicant who authorizes issuance of the standby
6
Article 1.02 a. and b. ISP98 7 Article 1.03 ISP98 8
Article 1.03 b. ISP98 9
Article 1.03. d. ISP98 10
or otherwise agrees to the application of these rules”. (International Commerce Chamber, 1998). Matters regarding Due Issuance and Fraudulent or Abusive Drawing of the standby LC are excluded expressly from the ISP98, and are left to the national applicable law11.
According to the ISP98, the general principles of the standby LCs are divided in three categories: Nature of standbys, Independence of the issuer-beneficiary relationship, and the limits to responsibilities. The Nature of a standby is the following12: “a standby is an irrevocable, independent, documentary, and binding undertaking when issued and need not so state.” (International Commerce Chamber, 1998). As irrevocable, an issuer´s obligation
cannot be modified or cancelled by him, except if it follows the standby provisions, or if it’s consented by the person “against whom the amendment or cancellation is asserted”13
(International Commerce Chamber, 1998). As independent, the effectiveness of an issuer´s obligation does not depend on: the reimbursement issuer’s right, the beneficiary’s right, a reference in the standby to any reimbursement agreement or underlying transaction, or the issuer knowledge or performance or breach of any reimbursement agreement or underlying transaction14. As documentary, the issuer´s obligation depends on the submission of documentation and the examination of them on their face15. As binding when issued, it is effective upon the issuer, disregarding if the applicant authorized its issuance, the issuer received a fee, or the beneficiary received or relied on the standby or the amendment16.
The independence of the Issuer-beneficiary relationship contains the Doctrine of Independence. It means that “once the issuing bank issues a standby LC, it is bound to honour the beneficiary’s claim under such LC provided the claim is presented, together with other stipulated documents if any, in full compliance with terms and conditions of the standby LC.” (Sifri, 2008, pág. 16).
11 Article 1.05 ISP98 12
Article 1.06 ISP98 13 Article 1.06. b. ISP98 14
Article 1.06. c. ISP98 15
Article 1.06. d. ISP98 16
The responsibility of the standby LC’s issuer is limited. Therefore, the issuer is not responsible for the fulfillment or breach of any underlying transaction, or the characteristics of any document submitted under the standby, or the behavior of others even they are chosen by the issuer, or the compliance of any law or practice different than the one incorporated into the standby or applicable at the place of issuance17.
The ISP98 also provides several definitions regarding the standby LCs18. The most relevant are the following:
i. Applicant: is the person who pleads for the issuance of the LC. It includes a person applying in its own name but for the account of another person or an issuer acting for its own account.
ii. Beneficiary: is the person who has the right to require the payment of the standby. iii. Confirmer: it´s an additional undertaker of the standby, nominated by the issuer. iv. Demand: means either the request to settle a standby, or the document that makes
such request.
v. Document: means any representation of law, fact, right or opinion, which upon presentation19 can be examined for compliance with the terms and conditions of the standby.
Surpassed these provisions, the second rule of the ISP98 provides the obligations under a standby LC. The general obligation of the issuer is to honour a presentation that appears on its face to comply with the terms and conditions of the standby. It’s important to note that this is just a formal verification, not a substantive one. It’s similar to the verification that the exchange debtor must exercise in order to determine that a holder of a security is legitimate, and therefore honour the exchange obligation. (Trujillo Calle, 2012, pág. 59). The issuer honours the presentation by paying the amount demanded of it at sight, unless the standby provides a different honour. The different ways of honour are:
17
Article 1.08 ISP98 18
Article 1.09 ISP98 19
i. By acceptance of a draft drawn by the beneficiary on the issuer. In this case, the honour will be accomplished by timely accepting the draft and thereafter paying the holder of the draft20.
ii. By deferred payment, which is honoured by timely incurring a deferred payment obligation and thereafter paying at maturity21.
iii. By negotiation, in which case the issuer honours by paying the amount demanded at sight without recourse.
The term to honour a standby LC is provided in the Rule 5.01 of the ISP 98. The notice of dishonour must be sent within a reasonable time from the presentation. The reasonable time cannot exceed seven business days.
A standby LC is considered issued when it leaves the issuer’s control, unless it clearly states that is not then issued or enforceable. “Once the standby leaves the control of the issuer, it becomes an irrevocable binding instrument unless the standby states otherwise.” (Sifri, 2008, pág. 31). These conditions must be incorporated in the Standby LC. If not, they will be considered non-documentary22, and therefore disregarded. (Sifri, 2008, pág. 31).
Sometimes, the issuer nominates another bank (usually a bank located in the beneficiary domicile), to perform a specific task. This task could be “advice, receive a presentation, effect a transfer, confirm, pay, negotiate, incur a deferred payment obligation, or accept a draft.”23
(International Commerce Chamber, 1998). The nominated person must accept the task in order to be bound by it, and the nominated person cannot bind the person who nominates him24.
The rule 3 of the ISP98 regulates the presentation of the standby LCs. The issuer has to honour its obligation only when the documents are presented as the terms and conditions of
20
Article 2.01. b. i. ISP98 21 Article 2.01. b. ii. ISP 98 22
Article 4.11 ISP 98 23
Article 2.04. a. ISP98 24
the standby LC provides. A standby should indicate the time, place and location within that place and the medium of presentation. The standby may also provide the person to which the presentation must be submitted. (Sifri, 2008, pág. 38).
“The receipt of a document required by and presented under a standby constitutes a presentation requiring examination for compliance with the terms and conditions of the standby even if not all of the required documents have been presented”25
(International Commerce Chamber, 1998). This means that the beneficiary may present all or part of the documents required, and still the issuer or nominated person must perform the examination. This examination must be done in the time provided by Rule 5.03, and must determine if the documents comply with the standby LC provisions. If it doesn´t decides this matter within the time limit, it “will be precluded from claiming that the documents are not compliant and becomes obliged to honour its value.” (Sifri, 2008, pág. 39).
The presentation must clearly identify the standby LC that requires it. If it’s not clearly identified, this will produce unnecessary delays. This identification can be performed by clearly stating the complete reference number of the standby and the name and location of the issuer, or by attaching the original or a copy of the standby26. Hence, the issuer is not obliged to check the presentation until it’s fully identified the standby; neither is obliged to perform a search for the standby. If the standby expired before the presentation is identified, the issuer will consider it as a late presentation, and the beneficiary will assume responsibility27.
The presentation must be done at the place indicated in the standby. If the place is not indicated in the standby, the presentation must be made at the place of business from which the standby was issued28. The presentation must be done at any time after the issuance and before the expiration date29. It must be presented in the medium indicated by the standby. If
25
Article 3.02 ISP98 26 Article 3.03. b. ISP98 27
Article 3.03. c. ISP98 28
Article 3.04. b. ISP98 29
it doesn´t provide a medium, it must be presented as a paper document, unless only a demand is required30.
Rule 4 provides regulations for the Examination of the documents. Demands for honour of a standby must comply with the terms and conditions of the standby. The examination must be done on its face against the terms and conditions provided in the standby LC, and also according to the ISP98 rules. This means the ISP98 provisions are supplementary to the standby text. (Sifri, 2008, pág. 59). If there are several persons who must perform an examination (issuer and nominated bank), each person is responsible to make its own examination. Documents that aren’t required by the standby LC must not be object of examination31. The documents, as a general rule, must be issued by the beneficiary, unless the standby provides that they must be issued by a third person32. The documents need not be signed, unless the standby requires it. The signature must be made in a matter that corresponds to the medium in which the signed document is presented33.
If a standby doesn’t require the presentation of any document, it’s still necessary to present a documentary demand for payment34. A standby should not require a document that must be issued by the applicant of the standby35. This rule seeks to prevent the standby from becoming an inoperative instrument. If a standby term or condition is non-documentary, it must be disregarded36.
A required statement, as a general rule, needs no formality. Nevertheless, the standby can provide the addition of a formality, such as a sworn under oath, a witness or a counter-sign from a government representative37. When the issuer or the person deemed to perform the honouring of the presentation finds out it complies with the standby LC’s provisions, it’s
30
Article 3.06 ISP98 31
Article 4.02. ISP98 32 Article 4.05 ISP98 33
Article 4.07 ISP98 34 Article 4.08 ISP98 35
Article 4.10 ISP98 36
Article 4.11 ISP98 37
not obliged to verify the identity of the beneficiary38. The payment he does to the named beneficiary fulfills his obligation.
The standby documents can be of several types:
i. Demand for payment: it doesn’t need to be separated from the beneficiary’s statement or other required document. If it is required as a separate document, it must contain a demand for payment from the beneficiary to the issuer, the date of the demand issuance, the amount, and the beneficiary’s signature39.
ii. Statement of default or other drawing event: it must contain a representation to the effect that payment is due because a drawing event described in the standby occurred, the issuance date and the beneficiary’s signature40
.
iii. Negotiable documents: if the document is transferable by endorsement and delivery, it must be presented without endorsement, or with an endorsement in blank, and the document may be issued or negotiated with or without recourse41.
iv. Legal or judicial documents: this type of documents may include a government issued document, a court order, an arbitration award, or others. They must be issued by a government institution; they must be suitably titled, signed, and originally certified by an official of a government institution42.
v. Other documents: if a document different from the ones listed above is required in a standby LC, it will comply if it appears to be well titled or to serve the purpose of that type of document under standard standby practice.
Rule 5 of the ISP98 regulates the notice, preclusion and disposition of documents. As it was stated before, the notice of dishonour must be given between the seven business days after the presentation of the documents43. This notice must include all the reasons that support the dishonour. If the issuer fails to notice a discrepancy within the time and by the means
38 Article 4.13 ISP98 39
Article 4.16 ISP98 40 Article 4.17 ISP98 41
Article 4.18 ISP98 42
Article 4.19 ISP98 43
provided in the standby LC, it precludes from asserting any discrepancy contained in the documents. (Sifri, 2008, pág. 90), and must pay at maturity44.
If a notice of dishonour is delivered by the issuer on time, the presenter of the documents may request the applicant to waive non-compliance or to authorize the honour within the time available for giving notice of dishonour. The applicant waiver does not obligate the issuer to waive non-compliance45. An applicant may object the issuer’s honour of a noncomplying presentation by giving timely notice to the issuer46.
Rule 6 of the ISP98 regulates the transfer, assignment and transfer by operation of law of the standby LCs. A standby is not transferable unless it so states. If it’s transferable, it can be transferred as many times as desired, but cannot be partially transferred. The issuer or the person nominated by him needs to agree and effect the transfer requested by the beneficiary47. The issuer that pays to a transfer pursuant has the right to be reimbursed as if ti had made payment to the beneficiary48.
As a standby may be transferred, the beneficiary may also make an assignment of proceeds49. The issuer is not obligated to give effect to an assignment which it has not acknowledged50. An acknowledged assignment of proceeds confers no rights in regard to the standby to the assignee except the right to assigned proceeds. (Sifri, 2008, pág. 106). The rights of the assignee depend on “the existence of any net proceeds payable to the beneficiary by the person making the acknowledgement, the rights of nominated persons and transferee beneficiaries, rights of other acknowledged assignees, and any other rights of interests that may have priority under applicable law51. (International Commerce Chamber,
44
Article 5.03 ISP98 45
Article 5.05 ISP98 46 Article 5.09 ISP98 47
Article 6.03 ISP98 48 Article 6.05 ISP98 49
Article 6.06 ISP98 50
Article 6.07 ISP98 51
1998). The acknowledgement can be conditioned on receipt of several documents52. When they are conflicting claims to proceeds, payment to an acknowledged assignee may be suspended until the conflict is resolved53. When the issuer pays to an assignee, it is entitled to reimbursement of the payment as if it was made to the beneficiary.
Rule 7 of the ISP98 deals with the cancellation of a standby LC. The beneficiary’s rights emerged from a standby LC may not be cancelled, unless he approves it. His consent must be evidenced in writing or by any other action in a manner which implies that the beneficiary consents to cancellation. Once the cancellation is communicated to the issuer, it becomes irrevocable. Issuers may require reasonable measures before acceding to a beneficiary’s authorization to cancel a standby such as: the original standby, the verification of the signature of the person signing for the beneficiary, a legal opinion, or any other54.
Rule 8 of the ISP98 deals with reimbursement obligations. Where settlement is made on behalf of a compliance presentation, the following persons have the obligation to reimburse:
i. The applicant to the issuer requested to issue the standby
ii. The issuer to a person nominated to honour or otherwise give value55.
The applicant must indemnify the issuer against any legal claims regarding the standby applicable law, fraud or illegal action of others or the issuer’s performance of the obligation of a confirmer that wrongfully dishonours a confirmation56.
Rule 9 of the ISP98 regulates the timing of the standby LCs. A standby must contain an expiry date or permit the issuer to terminate the standby upon a reasonable prior notice or payment57. The rights of a nominated person are not affected by the expiration of the
52 Article 6.08 ISP98 53
Article 6.09 ISP98 54 Article 7.02 ISP98 55
Article 8.01 IPS98 56
Article 8.01.b. ISP98 57
standby. All time periods start to count on the next business day following the business day when the action could have been undertaken at the place where the action should have been undertaken58. “Retention of the original standby does not preserve any rights under the standby after the right to demand payment ceases.”59
(International Commerce Chamber, 1998).
Rule 10 of the ISP98 deals with syndication and participation. If a standby has more than one issuer, and doesn’t specify to whom it must be presented, the presentation may be done to any of the issuers with binding effects on all issuers60. The issuer may sell its rights against the applicant and any presenter and may reveal relevant information of the applicant in confidence to potential participants61. The sale of participation doesn’t affect the issuer’s obligations on behalf of the standby, and doesn’t create obligations between participants and the beneficiary.
National regulation
In order to determine which the applicable law is in the Colombian legal system is necessary to define the nature of the standby LCs. The LC’s general function is to serve as a mean of payment: the seller seeks payment as soon as possible. The traditional LCs serve as payment instruments or funding facilities of international commerce operations. However, standby LCs, which maintain their nature of letters of credit, serve as settlement guarantees of obligations, not as means of payment (Superintendencia Financiera, 1999).
Therefore, standby and traditional LCs are classified in the documentary credit category, defined in the 1408 article of the Code of Commerce (CC) as the agreement through which, in request and according to the client’s instructions, the bank commits directly or through a correspondent bank to pay a determined amount of money to a beneficiary, or to pay, accept or negotiate bills of Exchange issued by the beneficiary, effective with the
58 Article 9.03 ISP98 59
Article 9.05 ISP98 60
Article 10.01 ISP98 61
submission of the accorded documentation and following the terms and conditions established (Superintendencia Financiera, 1999).
In this regard, the legal nature of the standby LC is the one of a personal bail bond, classified as a suretyship62, which, according to the article 2361 of the Civil Code, is defined as an accessory obligation, under which one or more persons assume a third person duty, committing to accomplish it in case the main debtor doesn’t. Then, the standby LC is a personal guarantee (Superintendencia Financiera, 1994).
Once defined the legal nature, it’s important to establish the applicable law. As a letter of credit, it’s regulated in the articles 1408 and following of the Code of Commerce. As a security, it´s ruled by the articles 2361 and following of the Civil Code. Since these norms fail to provide detailed regulation to the standby LC, the regulatory gap has been filled through contractual and customary rules that incorporate international regulations, such as the UCP 600 and the ISP 98 (Superintendencia Financiera, 1999). It’s also ruled by the Financial Superintendence 007 Basic Legal Circular of 199663.
In Colombia, the financial entities need legal authorization to develop their activities. Therefore, in order to grant standby LCs, financial entities need authorization. Indeed, Banks and Financial Corporations have the legal authorization to issue LCs in development of their main corporate purpose, under the paragraph g) of the article 7 (for Banks), and under the paragraph e) of the article 12, of the 663 Decree of 1993, also known as the Financial System Organic Statute.
In regard of the standby LC, the authorization stems from the article 1 of the 923 Decree of the 2 April, 1997, which authorized the issuance of standby LCs to the financial institutions legally capable to issue traditional LCs (Banks and Financial Corporations) (Superintendencia Financiera, 1999).
62
The Spanish legal term is “fianza”. 63
Once listed the national applicable law to the standby LC, it’s important to analyze the specific regulations on the matter. First, the regulations under the Code of Commerce will be object of analysis.
Commerce Code
The documentary credit is defined as the agreement through which, in request and according to the client’s instructions, the bank commits directly or through a correspondent bank to pay a determined amount of money to a beneficiary, or to pay, accept or negotiate bills of Exchange issued by the beneficiary, effective with the submission of the accorded documentation and following the terms and conditions established64.
The letters of credit must contain65:
i. The name of the issuer bank and the correspondent bank, in case it exists ii. The name of the applicant
iii. The name of the beneficiary
iv. The maximum amount of money that must be settled, or the amount that can be issued as letters of exchange on charge of the issuer or the seconding bank.
v. The credit expiry date
vi. The documents and requisites required of presentation or accreditation for the credit effectiveness.
The documentary credit can be revocable or irrevocable. As a general rule, the credit is revocable, unless the LC provides the contrary66. The issuer bank can revoke the credit at any time, as long as it has not been used by the beneficiary67. These rules are substantially different from the rules under the ISP98, which provide that standby LCs are, as a general rule, irrevocable, unless the LC provides the contrary. Under the Code of Commerce rules, a bank may revoke the credit, but under the ISP98, it forbidden to revoke it.
64 Article 1408, Code of Commerce 65
Article 1409 Code of Commerce 66
Article 1410 Code of Commerce 67
The irrevocable LC must always express the expiry date. In the revocable, in case there’s no expiry date, it will be of six months from the date the bank notifies the credit beneficiary that the credit is effective68.
A letter of credit will be object of transfer whenever it authorized by it. In case it’s not expressly forbidden, the credit could be transferred by fractions until fulfillment of its account. In turn, it could only be used partially when the LC expressly authorize it69. This provision doesn’t conflict with the ISP98 regulations. The ISP98 provides that, as a general rule, standby LCs are not transferable, but they can be if the standby provides it. It also provides an express prohibition to transfer portions of the standby beneficiary rights, which will comply with the national regulation.
In regard to the bank responsibility, the intervention of a bank different from the issuer to provide advice to the beneficiary of a credit issuance, doesn´t impose an obligation as a seconding bank, unless it accepts to confirm the credit. In this case, the confirming bank will become responsible upon the beneficiary in the same terms as the issuer, from the date of the confirmation70. This provision complies with the ISP98, which regulates in the same sense the obligations of persons different from the issuer (noticed banks, confirmers, and others).
In terms independence, the LC is independent of the contract under which the open credit must be applied. Hence, neither the issuer bank nor the correspondent bank, will acquire any obligation in regard to the form, sufficiency, accuracy, authenticity, fraud or legal effect of any document regarding such contract71. This independence principle is the pillar of the standby letter of credit under the ISP98 regulations.
Civil Code
68 Article 1412 Code of Commerce 69
Article 1413 Code of Commerce 70
Article 1414 Code of Commerce 71
Once the regulations of the Commerce code were analyzed, it’s time to do the same with the civil code provisions. As stated before, the Financial Superintendence has catalogued standby letters of credit as securities (fianza). This term, if analyzed under the terminology explained in the introductory part of this text, would refer to a “suretyship”, which is a security that is accessory to the main obligation. Therefore, it’s unreasonable under a historical and methodological approach, that standby letters of credit were catalogued as “suretyships” in our legal system, when they represent exactly the opposite category; the independent guarantees. This technical mistake creates serious incompliances between the civil code provisions and the ISP98 regulations.
The security72 or suretyship (fianza) is an accessory obligation, under which one or more persons respond for a third person obligation, committing with the creditor to fully or partially accomplish it, in case the principal debtor breaches. The suretyship may be granted in favor of the principal or a co-debtor73. From the definition, it’s evident that standby letters of credit are substantially different from suretyships. For instance, the most radical difference regards to the relationship between the guarantee and the main obligation. The suretyship is accessory to the main obligation, and as such, its existence depends of the outcome of the main obligation. On the other hand, the standby LC (equivalent to the continental law independent guarantee), is independent from the main obligation, and its existence doesn’t depend on the outcome of the main obligation. Therefore, there´s a substantial incompliance between our national laws and the international regulations governing the standby LC.
Moving forward, a future obligation is susceptible of suretyship; in which case the guarantor may revoke its guarantee as long as the principle obligation doesn’t exist74. This clearly contradicts the principle of irrevocability of the standby LC, allowing the issuer to revoke the standby.
72
From no won I will refer to the fianza as a suretyship. 73
Article 2361 Civil Code 74
The suretyship has some limitations that severely damage the application of the standby LC in our country. For example, the guarantor’s obligation cannot exceed the original debtor’s obligation75. In case it exceeds it, it must be reduced under the same terms of the main obligation76. This clearly jeopardizes the usage of standby LCs in Colombia. Additionally, when a third person action is guaranteed, only the repairing on behalf of the breaching of the obligation is guaranteed77. This excludes the mayor subjects a standby letter of credit can guarantee.
In regard of the relationship between the applicant, the issuer and the beneficiary of the standby LC, there’s a clear contradiction with the suretyship rules. In case of insolvency of the guarantor, the debtor will be obliged to provide a new suretyship78. This is contrary to the customary rules for standby LCs, which provide that the insolvency of one party doesn’t affect the rights and obligations of the others.
Under the suretyship, the guarantor can oppose to the creditor any real exceptions, such as wilful misconduct, violence or res judicata79. In standby LCs, the only admissible exception is fraud of the documentation. It has also the benefit of excussio, under which it can demand that the creditor first executes the main debtor80. In standby LCs, is unbearable that the issuer can require the beneficiary to go after the applicant’s equity in the first place. In fact, the only requirement the beneficiary has to comply is the presentation of the documents provided by the standby.
The suretyship, as an accessory obligation, will expire if the main obligation expires81. The standby LC, as an independent obligation, remains event if the guaranteed obligation expires.
75
Article 2369 Civil Code 76 Article 2370 Civil Code 77
Article 2368 Civil Code 78 Article 2375 Civil Code 79
Article 2380 Civil Code 80
Article 2383 Civil Code 81
Financial Superintendence 007 Basic Legal Circular of 1996
This regulation develops the characteristics of the documentary credits in accordance with the Code of Commerce provisions on the matter. As a first assessment, it argues that the letters of credit are not equivalent to the mandate contract82. Then, it enunciates the main characteristics of the documentary credit, such as the autonomy of the relationships between each party in a LC, the literal nature of the LCs, which obligations are the ones written on the instrument, and the literal nature, which refers to the presentation of the documents in order for a LC to become effective83.
Lack of regulation
Consequently, in Colombia there´s no specific regulation that rules over the standby LC. All the provisions mentioned above regulate Letters of Credit in general, or documentary credit, or the suretyship, which is substantially different. As a result of this legal vacuum, parties engaging in transactions guaranteed by this instrument, incorporate international uniform regulations, such as the ISP98 or the UCP 600, explained above, to state their obligations under the standby LC.
If parties had to limit their contracting intent to the national legal system, they would face the legal insecurity of the vacuum. They would have to fill this vacuum with doctrine from the Financial Superintendence, which has been contradictory in the definition and applicable law of the standby LC, where it considers it as a suretyship in their concepts, but not in their Basic Legal Circular.
It is more convenient to incorporate these international uniform regulations that are issued by experts in international business who understand perfectly the origin, meaning, uses and development of the standby LC, than to limit to contradictory laws in the Colombian legal
82
Article 6.1, Title II, Chapter 1, Financial Superintendence 007 Basic Legal Circular of 1996 83
system. This practice has been accepted in several arbitral awards. Under these rulings, it is acknowledged that the Code of Commerce limited to regulate the fundamental issues of the documentary credit, to avoid inconveniences that could derive on a rigid regulation, because under this circumstance, it will be difficult to adapt to the changes in the development of the business. This problem is avoided by using the international uniform regulations, because there are constantly revised by the International Chamber of Commerce. By incorporating these international regulations in the text of the standby LC, it becomes law designated by the parties as applicable. (Laudo Arbitral Cadenalco S.A. vs. Corfinsura S.A. , 1999).
(Hinestrosa, 1986)
That said, it is necessary to analyze the party autonomy in the commercial field. Under this autonomy, the parties have the power to regulate their own agreements as long as it concurs with the legal system (Hinestrosa, 1986, pág. 11). Therefore, this autonomy is not unlimited, because it must comply with the public policy, acknowledged as political diktats that strictly overlap the primacy of the general interest over the individual and lead the private activity according to what’s more convenient for the whole community (Hinestrosa, 1986). The article 4 of the Code of Commerce provides that the party agreements take precedence over the default legal rules and business customs and practices.
Therefore, the business relationships are in first place subject to the public policy rules, then to the party agreements, and then to default and customary rules.
Regarding to public policy rules, they impose limitations to the party autonomy, or impose sanctions, or establish regulations that are not susceptible of modifications or derogations under private agreements. They inspire on principles closely related to the notion of public order in its triple dimension of Nation Security, public morality and third person protection. Therefore, they must always be complied and they manifest in express and unequivocal texts that, seen from another angle, are of strict interpretation and application. To identify this type of rule, it must be assessed that its transgression violates the public policy, because it undermines the National Security, the public morality or third person rights.
Instead, the default rules seek only to protect the party interests (Narváez García, 2002, pág. 109).
Hence, for each specific case, it must be assessed if the party agreements undermine any rule which is considered a public policy one. In the standby LC case, I consider, after all the investigation showed above, that there are no public policy rules in the Colombian legal system that regulate this instrument. The rules cited above regulate in general the documentary credit and the suretyship, but are not public policy rules. Therefore, they can be superseded by International uniform regulations via party agreements.
III. CONCLUSIONS
The applicable law to a standby LC in the Colombian legal system follows these simple rules:
i. Regarding national laws and regulations, standby letters of credit are governed by the provisions of the documentary credit under the Code of Commerce. They are also governed by the norms of the suretyship (fianza) under the Civil Code. In the third place, they are guided by the regulations of the documentary credit under the Financial Superintendence 007 Basic Legal Circular of 1996.
ii. Regarding international rules of practice, they will apply to a standby LC only if the instrument expressly provides that it is ruled by any or several international rules of practices, such as the ISP98 or the UCP 600.
In case of a contradiction between a national law and an international rule of practice, the following assessment is required:
i. Determine the degree of the national provision. ¿is it a public policy rule? ¿does it admits otherwise agreed clauses?
ii. If it admits otherwise agreed clauses, the international rule of practice will be considered as an otherwise agreed clause incorporated into de LC, and therefore will prevail over the national rule.
iii. If the national provision is a public policy rule, it doesn´t admit otherwise agreed clauses; hence, the national rule will prevail over the international rule of practice. iv. Depending on your assessment, decide which rules are applicable to the standby
LC.
After this investigation, the following conclusions were obtained:
1. The financial superintendence misunderstood the nature of the standby LC, when it catalogued it as a suretyship (fianza), because a historical and methodological approach evidences that it is equivalent to the opposite category; the independent guarantee. 2. This mistake may imply a serious threat to the usage of standby LCs in our legal
system, because contradictions between public policy rules under the Civil Code, regarding the suretyship, and international rules of practice regarding the standby LC could represent a practical inoperativeness of this instrument.
3. Apart from the national rules regarding the suretyship, the other national rules that govern the standby LC do not pose a threat to its application.
4. After an assessment of the national rules related to the standby LC, they haven’t the decree of public policy rules, and therefore they can be superseded by International Uniform regulations, incorporated in the standby text by the parties.
Nevertheless, the concepts of the Financial Superintendence still pose a threat to this instrument, if followed strictly. In order to prevent this threat, the following solutions are proposed:
1. The financial superintendence could publish a concept clarifying the nature of the standby LCs. In this clarification, it must separate this instrument from the suretyship, and explain the equivalence with the independent guarantees. This will repair the damage made by the initial misunderstanding.
2. The financial superintendence could publish a concept clarifying that, although standby LCs have similarities with the suretyship, its provisions are not public policy rules, and therefore they admit otherwise agreed clauses. This solution, although it’s still wrong
under a conceptual perspective, will prevent the operative threats of the suretyship rules.
3. Ignore the classification made by the Financial Superintendence, and therefore apply the interpretation given in this text, which permits the parties to supersede the default national rules with the International uniform regulations.
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