SHIPPING GUARANTEES AND DISCREPANT DOCUMENTS

QUESTION

Dear Mr Old Man,

Pls give your comments for the case as following:

The issuing bank issue the shipping guarantee to enable the applicant to take delivery of goods without original B/L (of course, the IS Bank asked for applicant to accept the docs as presented).

The risk is that if the issuing Bank receive the discrepant docs, for example claimed invoice value exceed guaranteed amount for additional charges/or exceed the l/c value

Is the Issuing bank required to pay extra amount on invoice (in case within L/C value and the case exceed L/C value) or in any case, the issuing Bank’s liability is only L/C amount?

Thanks and best regards
Hien-VCB

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ANSWER

Dear Hien,

When issuing a shipping guarantee to enable the applicant to take delivery of the goods without production of original bill of lading, the issuing bank is deemed to be liable for payment of the documents presented under the L/C irrespective of any discrepancies including “overdrawn”. In this event the issuing bank may bear the risk of paying the amount in excess of the L/C amount.

To mitigate this risk, the issuing bank should agree to issue a shipping guarantee only when the applicant commits to accept all discrepancies including “overdrawn” and to fully reimburse the issuing bank the amount that the issuing bank has paid (including the overdrawn amount).

Soh Chee Seng wrote an interesting article titled “Shipping guaranree and discrepant document” in DCInsight. I quote herebelow for your reference:

Best regards,
Mr. Old Man
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Shipping guarantees and discrepant documents

By Soh Chee Seng

Is a bank that authorises release of goods consigned to it under a documentary letter of credit against issuance of a shipping guarantee obliged to take up the underlying documents and effect payment?
This issue was raised at the recent ICC Banking Commission meeting in Moscow and caused much disagreement between the bankers present. The topic raised its head again in the discussion forum of DC-PRO and again it proved divisive.

Some feel strongly that the bank is obliged to take up documents irrespective of any discrepancies contained in the documents. Indeed, there are those who have gone so far as to say that the Documents need not be checked for compliance under the credit.

Others have taken the polar opposite view.
So, what is the correct stance to take? Should payment be automatic once the bank has arranged for release of the goods under the credit? Should the documents be checked?

The shipping guarantee

A shipping guarantee is a guarantee that may be made by a bank to a shipping company indemnifying the shipping company for the release of cargo prior to their receipt of an original bill of lading.
In most countries a shipping guarantee is an evergreen guarantee. It does not have an expiry date. It can only be redeemed upon surrendering the underlying original bill of lading to the shipping company.
The shipping guarantee can be of considerable convenience to importers; cargo can be cleared without long delays and demurrage charges avoided.
However, there is considerable risk attached to the issuance of shipping guarantees for banks. This is primarily because banks do not know the actual value of the cargo covered under its shipping guarantee, even though the cargo may be shipped under its documentary letter of credit.
Banks mainly rely on the declaration and copy of the invoice given by its customer. Because of this risk attached to the issuance of shipping guarantees, most prudent banks offer this facility infrequently, and only to financially trustworthy customers.

The letter of credit

As we all know, the core principle of Letters of Credit is that a bank (the issuing bank) provides its definite undertaking to pay against documents that comply with the terms and conditions of the credit and the provisions of UCP 500.
If the documents do not comply, the bank's undertaking lapses and it is not obliged to take up the documents.
It is clear in the UCP 500 that the bank's undertaking in its documentary letter of credit is to pay against compliant documents. It will be precluded from claiming that the documents are not in compliance with the terms and conditions of its letter of credit only if it fails to comply with the provisions in UCP 500. There are no provisions in the UCP 500 that the bank is bound to take up the discrepant documents if it has authorised the release of goods by issuance of a shipping guarantee.

Shipping guarantee and letter of credit

Individually, the responsibility of a bank under both Letter of Credit and shipping guarantee is very clear. It is when the two are looked at in tandem that the lines are blurred and confusion arises.
Again, a bank that authorises release of goods by issuance of a shipping guarantee is liable to the shipping company as the guarantee indemnifies the shipping company for the release of cargo without receiving the original bill of lading. It is separate from the undertaking given by banks in a documentary letter of credit.

Most banks require their customers to accept all discrepancies identified in the presentation of documents if they apply for a shipping guarantee in favour of a shipping company. So, it should not be a problem for banks to pay against presentation of discrepant documents if there is no collusion between beneficiary and applicant or fraud by the beneficiary.
However, if there is collusion between beneficiary and applicant or fraud by the beneficiary, banks may suffer heavy losses if they pay against presentation of discrepant documents.

Collusion between beneficiary and applicant

When an applicant wants a letter of credit far in excess of the credit limit granted by its issuing bank, it may collude with the beneficiary to accept a letter of credit for an amount acceptable by the issuing bank. And in turn a letter of credit to be issued by the Issuing Bank for the smaller amount agreed between the parties.

When the shipment arrives, the applicant may reimburse the issuing bank for the credit amount and apply for a shipping guarantee. The beneficiary will then draw an invoice and present documents under the credit in excess of the amount permitted in the credit.
The applicant may not be in a position to reimburse the issuing bank for the difference in the amount in excess of the credit amount.

While the bank may refuse payment under its letter of credit as the amount is overdrawn, it has an obligation under the shipping guarantee. It may be required to compensate for losses suffered by the shipping company if the shipper wishes to take action against the shipping company for the release of cargo without receiving the original bill of lading.

Let's look at an example:

Company A had a credit line of USD100,000 for the issuance of letter of credit with Bank I against 100% cash deposit.
Company A wished to import "one lot of electronic devices" for an amount of USD250,000 but it was not able to place an additional amount of USD150,000 with the bank.
Company A contacted and colluded with the supplier, Company X, to accept the letter of credit for an amount of USD100,000.
Bank I, without any knowledge of the collusion between Company A and Company X, issued a letter of credit for USD100,000 covering shipment of "one lot of electronic devices" in favour of Company X.
When the shipment arrived, Company A applied for a shipping guarantee in favour of the shipping company. Bank I approved the shipping guarantee as the value was declared as USD100,000 only.
But when documents were presented, Bank I was sho
cked to see that the amount claimed under its credit was USD250,000.

What did Bank I do?

Firstly, Bank I checked the documents. The documents did not comply so it issued a notice of refusal to the beneficiary citing the discrepancies.
When the beneficiary received the notice of refusal it asked for the documents to be returned. On receiving the documents, it then instructed the shipping company to return all cargo or pay for the cargo.
As the goods had already been released, the shipping company claimed under the shipping guarantee on Bank I.
Bank I sought the protection of the courts against the collusion that had taken place between Company A and Company X.
It was a matter of law whether or not Bank I had to pay the shipping company under the shipping guarantee.

Fraud by the beneficiary

Although banks deal with documents under a documentary letter of credit operation, they may still encounter problems if there is fraud committed by the beneficiary.

Let's look at another example for illustrative purposes:

Bank I issued a letter of credit for an amount of USD3,000,000 covering shipment of "iron ore" at the request of Company A, the applicant, in favour of Company B the beneficiary.
Prior to receipt of the underlying shipping documents, the shipment arrived. Company A applied for a shipping guarantee with Bank I. When Company A accessed the container, instead of iron ore it discovered it had been shipped useless scrap metal.

Company A immediately notified Bank I to stop payment under the letter of credit and at the same time applied for court injunction. On obtaining the court injunction, Company A instituted legal action against Company B.

What did Bank I do?

Firstly, Bank I checked the documents. The documents did not comply (late shipment and inspection certificate not presented), so it issued a notice of refusal to the beneficiary citing the discrepancies.

If Bank I had paid out against the discrepant documents as a result of the condition in the shipping guarantee to accept all discrepancies identified in the documents, Company A might also initiate legal action against Bank I.

Conclusion

A prudent issuing bank should examine documents presented under a letter of credit even if the goods to which the credit relates have been released against a shipping guarantee authorised by the issuing bank.

The issuing bank should notify the applicant on the arrival of documents. It is applicant's duty to inform the issuing bank if it discovers any irregularity with the shipment.

If there is no collusion between the applicant and the beneficiary or fraud by the beneficiary, the issuing bank is obliged to take up the documents even if the documents are discrepant. Otherwise, issuing bank can refuse to take up the discrepant documents, as the two instruments are separate and different obligations of the issuing bank.