Prepay vs. Purchase – Same Same but Different?

A reader recently asked Mr. Old Man a deceptively simple question:

If “prepay” and “purchase” under UCP 600 Article 12(b) essentially produce the same commercial result, why does the definition of negotiation mention only “purchase”?

An excellent question.

The answer lies not only in the wording of UCP 600 but also in the legal distinction between an accepted draft and a deferred payment undertaking, as well as the legacy of a well-known court case that influenced the drafting of Article 12(b).

Let’s explore.

Question

Dear Mr. Old Man,

Hope you are doing well.

A small query regarding terminology:

Under Article 12(b) of UCP 600, what is the difference between “prepay” and “purchase”? Please also refer to the definition of negotiation, which uses the term “purchase” only and does not include “prepay”.

Many thanks.

Best regards,
Arun Ambar

_______

Answer

Dear Arun,

Thank you for your question.

Under Article 12(b) of UCP 600, the terms “prepay” and “purchase” essentially have the same commercial effect. In both cases, the nominated bank advances funds by discounting a draft accepted by itself or a deferred payment undertaking incurred by itself.

From the wording of Article 12(b), both terms refer to the nominated bank paying before maturity against its own accepted draft or deferred payment undertaking.

However, in my opinion, there is a legal distinction between the two terms. The word “prepay” is more appropriately used in connection with a deferred payment undertaking, whereas “purchase” is more appropriately associated with an accepted draft.

This distinction may also explain why UCP 600 uses only the term “purchase” in the definition of negotiation, namely, “the purchase by the nominated bank of drafts…”

It is worth noting that the inclusion of Article 12(b) in UCP 600 was largely influenced by the court decision in Banco Santander SA v Banque Paribas, which highlighted the need to expressly recognize a nominated bank’s ability to discount its own deferred payment undertaking.

Best regards,

Mr. Old Man