SHOULD THE CONCEPT OF “NEGOTIATION” CONTINUE TO EXIST IN THE UCP?

Nguyen Huu Duc

The recent UCP revision process has had debates on the question “Should the concept of “negotiation” continue to exist in the future UCP revision?”. Some experts believe that ICC should remove the type of letter of credit available by negotiation from the upcoming UCP revision, while many experts believe that the concept of “negotiation” should continue to be retained with a clearer definition.

Previously, I have had some articles published in the Banking Review and the Financial & Monetary Market Review discussing the term “negotiation” and the issue of negotiation in letter of credit transactions in UCP 500 and UCP 600. On UCP 600 being revised by ICC, I would like to discuss once again the concept of “negotiation”, whether this type of letter of credit should continue to be maintained in the future version of UCP.

Origin of the term “negotiation”

The term “negotiation” in UCP is confusing. Even when translated into another language, “negotiation” has different names.

The term “negotiation” appeared in the UCP very early and the definitions of this term were considered confusing and had to be changed after many revisions of the UCP.

If UCP 82 (First Edition ICC1933), Article 38 stipulates that a letter of credit has only one form of payment availability, which is available by payment when the complying documents are presented within the validity of the letter of credit, later revisions of the UCP have expanded the form of payment availability, accordingly, the letter of credit can be available by negotiation, available by payment, available by acceptance and available by deferred payment. Specifically:

UCP 151 (ICC 1951 Revision), Article 10 provides that a letter of credit is available by acceptance and available by negotiation.

UCP 222 (ICC 1962 Revision), Article 35 provides that a letter of credit is available by sight payment, by acceptance and by negotiation with an authorized bank.

UCP 290 (ICC 1974 Revision), General Terms & Definitions (e) introduces the concept of a letter of credit that is freely negotiable by any bank.

UCP 400 (ICC 1983 Revision) specifies that a letter of credit is available by negotiation with any bank. In this case, any bank is a nominated bank.

UCP 500 (ICC Revision 1993), Article 10 defines the term “negotiation” as follows: “Negotiation means the giving of the value for Draft(s) and/or document(s) by the bank authorized to negotiate”.

The definition of the term “negotiation” in Article 10 of UCP 500, according to experts, is unclear, causing the practitioners of letters of credit at that time to understand it in their own way, even using it in a distorted way to the point that when drafting the revision of the UCP, many experts even proposed to remove the term “negotiation” from UCP 600. However, it was finally retained with a clearer definition.

UCP 600 (ICC 2007 Revision), Article 2 changed the definition of the term “negotiation” of UCP 500 as follows: “Negotiation means the purchase by the nominated bank of drafts (drawn on a bank other than the nominated bank) and/or documents, by either advancing or agreeing to advance funds to the beneficiary on or before the banking day on which reimbursement is due to the nominated bank”.

Compared to the definition in Article 10 (b)(ii) UCP 500, the new definition in Article 2 UCP 600 is much clearer and easier to understand. The phrase “the giving of the value” in Article 10 (b)(ii) UCP 500, which was famous for its ambiguity, was replaced by the very simple word “purchase”, which is the act of the nominated bank purchasing bills of exchange and/or documents by prepaying or agreeing to prepay to the beneficiary on or before the day the nominated negotiating bank receives reimbursement from the issuing bank or the confirming bank (if any).

In UCP 600, the concept of negotiation is applied to the letter of credit available by negotiation. Accordingly, the issuing bank authorizes the nominated bank to negotiate when the presented documents comply with the terms and conditions of the letter of credit and undertakes to reimburse the nominated negotiating bank. Depending on the letter of credit, the nominated bank may be a named nominated bank, any bank or a confirming bank. The nominated bank may refuse to negotiate or agree to negotiate without recourse or with recourse. However, the confirming bank must negotiate without recourse when the presented documents comply.

Should “negotiation” continue to exist in the UCP?

In the debates on international payment operations, many experts believe that the letter of credit available by negotiation should be eliminated.

Laurence Bacon’s opinion is a typical example. He believes that in the majority of “negotiation” letters of credit in which he has availed of it, the reason for doing so, had little or nothing to do with its definition in article 2, and more to do with covering FOREX risks.  As these choices are purely commercial, there is no mention of them in any version of UCP, which begs the question as to why there is any mention of “negotiation” at all.

Bob Ronai, ICC expert, argues that negotiation is a private arrangement. It is the choice of the negotiating bank based on their assessment of risk including their assessment of the issuing bank. The negotiating bank must also assess whether the beneficiary would be capable of refunding the prepayment if the issuing bank fails to honour. There is therefore a form of contract between the negotiating bank and the beneficiary stating the terms and conditions of this prepayment and does not involve the issuing bank. It is not controlled by the issuing bank and therefore there is no point in having the concept mentioned in UCP600.

I had a long debate with Bob Ronai on LinkedIn. In my opinion, negotiation should continue to exist in the UCP because up to now, letter of credit is a payment method that accounts for a large proportion in developing countries, in which letter of credit available by negotiation is recorded to account for 70-75% of all types of letters of credit. In terms of legality, once issuing a letter of credit available by negotiation with a nominated bank, the issuing bank is considered to have authorized the nominated bank to negotiate when the presented documents are complying with the terms and conditions of the letter of credit and undertakes to reimburse the negotiating bank. Therefore, when the beneficiary presents complying documents and requests the nominated bank to negotiate, the nominated bank may agree to negotiate because it will certainly be reimbursed by the issuing bank and can sue the issuing bank on its own behalf in case of not receiving the reimbursement.

In fact, the problem is not with the letter of credit available by negotiation, but the draft presented under the letter of credit is the problem because there are too many controversies related to whether the draft is considered a document presented under the letter of credit and whether discrepancies on the draft constitute a valid reason for the issuing bank to refuse to reimburse the negotiating bank. In my opinion, the future version of UCP should still retain the concept of negotiation and the letter of credit available by negotiation, just remove drafts from this type of letter of credit according to the conclusion and recommendation of the ICC in the Guidance Paper – The Use of Drafts under Documentary Credits.

In the article “Should “Negotiation” Continue to be a Form of Availability within UCP?”, Dave Meynell – Senior Technical Advisor to the ICC Banking Commission – proposes a new definition of the term “negotiation” for the revised version of the UCP as follows:

“Negotiation is the act by which a nominated bank, under a credit available by negotiation, advances funds or agrees to advance funds to the beneficiary against a complying presentation of documents, prior to receiving reimbursement from the issuing bank. This advance or agreement to advance funds occurs on or before the banking day on which reimbursement is due to the nominated bank. Negotiation does not involve the purchase of drafts and/or documents, but rather the provision of financing based on the nominated bank’s assessment of the complying presentation and the issuing bank’s obligation to reimburse.”

According to Dave Meynell, this alternative definition removes the concept of “purchase” of drafts and/or documents. It also eliminates reference to drafts drawn on banks other than the nominated bank, which supports the aim of the ICC to promote drafts becoming less common in practice. In essence, it emphasizes the financing aspect of negotiation, which is the core function in modern trade finance, clarifying that negotiation is an act of the nominated bank, distinguishing it from other forms of availability.

Frankly, apart from eliminating the draft, the definition proposed by Dave Meynell is also complicated. If asked to give a new definition for the concept of negotiation, I would venture to propose a simple definition as follows:

“Negotiation is the act of a nominated bank purchasing complying documents presented under a credit available by negotiation by advancing funds or agreeing to advance funds to the beneficiary on or before the banking day on which reimbursement is due to the nominated bank”.

Except for the removal of drafts, the above definition retains the spirit of the definition of “negotiation” in Article 2 of UCP 600. This is consistent with the ICC recommendation in the Guidance Paper – The Use of Drafts in Documentary Credits.

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References:

– Dave Meynell (2024). Should “Negotiation” Continue to be a Form of Availability within UCP? DCW 10/2024

– Nguyen Huu Duc (2007). Discussing the issue of negotiation in letter of credit transactions (in Vietnamese). State Bank of Vietnam Banking Review No. 10, May 2007

– Nguyen Huu Duc (2006). Discussing the term “negotiation” in letter of credit transactions (in Vietnamese). Financial and Monetary Market Review No. 14, July 2006

– Nguyen Huu Duc (2006). What’s new in UCP 600? (in Vietnamese) Banking Review No. 14, July 2006

– Nguyen Huu Duc (2006). UCP 600 before G-hour? (in Vietnamese) Banking Review No. 22, October 2006