Negotiation is not always what bankers think.

Negotiation may be the most abused, misused and misunderstood

word in the letter of credit business. In this regard, I am speaking
only as an L/C practitioner I am not a lawyer and not attempting to
deal with the term in a legal sense or with the holder in due course
doctrine. UCP 500 sub-article 10(b)(ii) states: Negotiation means the
giving of value for Draft(s) and/or document(s) by the bank authorised
to negotiate. Mere examination of the documents without giving of
value does not constitute a negotiation.

The latest UCP 600 defines negotiation this way: Negotiation

means the purchase by the nominated bank of drafts (drawn on a
bank other than the nominated bank) and/or documents under a
complying presentation, by advancing or agreeing to advance funds to
the beneficiary on or before the banking day on which reimbursement
is due to the nominated bank.

The words complying presentation are defined in sub-Article 2 of

the UCP 600 as Complying presentation means a presentation that is
in accordance with the terms and conditions of the credit, the
applicable provisions of these rules and international standard
banking practice.
In the United States letter of credit community, the historic practical
application of negotiation is the purchase of documents you are not
obligated to purchase, i.e., in many ways it is similar to your friend
endorsing a check over to you and your giving them cash for it. You
are not the bank; you did not write the check, but you are assisting
your friend who wants money now by buying the check from him,
and if the check bounces, you will go back to your friend and recover
your money.

More Than Examination

I also firmly believe a negotiating bank can give value by other

actions for example, by examining documents and providing services
to the beneficiary. Note that giving value is as tricky a term as
negotiating. Surely, the receipt of documents by a nominated bank
and a professional document examination by a reasonable document
checker, communication of noted discrepancies, etc., is a valuable
service! Unfortunately, the practice in some parts of the world is to
define document examination as negotiation. Mere document
examination, while extremely valuable, does not, constitute
negotiation.
In DCInsight, Volume 1 No. 1 Winter 1995, Charles del Busto, then
Chairman of the ICC Banking Commission, responded to a question on
the topic this way: if you want to classify yourself as a negotiating
bank, if you want to have the rights and protections under the laws of
the respective countries as a negotiating bank, you must do
something more than examine documents. You must buy those
documents, you must purchase those documents, you must give value
for those documents, you must become holder in due course , and we
believe that indeed constitutes negotiation in most jurisdictions. The
full article is too lengthy to reproduce here, but it is worth the
readers review.

Issuing and confirming banks

An issuing bank (issuer) cannot negotiate, because it must honor its

obligation under the credit - to either accept, incur a deferred
payment obligation or pay at sight this is ITS obligation. Even if
draft(s) are drawn on the applicant or if no drafts are required, it is
still the obligation of the issuing bank to honor conforming
documents. Some issuing banks say they have negotiated documents,
but in reality they mean they have honored them.

A confirming bank (confirmer) may negotiate. If the L/C drafts are

drawn on the issuing bank, a confirmer negotiates by purchasing
the draft(s) and documents, but it does so WITHOUT recourse to the
beneficiary. Therefore, a confirming bank does negotiate if the draft(s)
are drawn on another party or if there are no drafts.

UCP 600 sub-Article 8(a)(ii) states the obligation of a confirming

banking regarding negotiation as follows: a. Provided that the
stipulated documents are presented to the confirming bank or to any
other nominated bank and that they constitute a complying
presentation, the confirming bank must:

(ii) ii. negotiate, without recourse, if the credit is available by

negotiation with the confirming bank.

Sub-Articles 8(b) and 8(c):

b. A confirming bank is irrevocably bound to honour or negotiate as of
the time it adds its confirmation to the credit.

c. A confirming bank undertakes to reimburse another nominated

bank that has honoured or negotiated a complying presentation and
forwarded the documents to the confirming bank.

A confirmer would become the PAYING bank if the drafts were drawn
on it, or if it were a sight credit with no drafts and the credit were
available by payment at its counters. A bank that is not the drawee
bank with regard to the drafts can negotiate the draft(s) and
documents (i.e., the drafts are drawn on someone else and a bank
decides to assist its client by advancing funds to it (making a loan)
against the anticipated receipt of funds to come from the issuing or
confirming bank. A bank may choose to advance funds (give value)
with or without recourse. In my opinion, this represents true
negotiation in the historic sense.

A Nominated Negotiating Bank

Having a bank nominated in the credit as the negotiating bank, or
having a freely negotiable credit where any bank can negotiate,
benefits the beneficiary of the L/C, because it permits the beneficiary
to present its documents to the negotiating bank. This presentation of
complying documents obligates the issuing bank under the terms and
conditions of its credit. The documents do not have to reach the
issuing bank by a specific time; mere presentation to a nominated
bank per the credit terms obligates the issuer to honor.

Interestingly, the nominated bank with which the beneficiary lodges

its documents is not obligated to examine or negotiate the documents.
In fact, a beneficiary may attempt to present its documents to a
nominated negotiating bank and, absent confirmation by that bank,
the bank is not even obligated to accept the presentation! Difficult to
imagine, but possible.

A nominated negotiating bank today typically examines the documents

against the terms and conditions of the credit, informs the beneficiary
of discrepancies (if any) and forwards the documents to the issuing or
confirming bank for honor. Note this practice of receipt, examination
and forwarding by a nominated negotiating bank is of value, but does
not constitute negotiation. The critical benefit to a beneficiary of a
negotiation credit is having the right to place its documents in the
hands of a nominated bank within the terms and conditions of the
credit, thus satisfying the initial requirement for documents to reach a
given bank by a given time and obligating the issuer.

A bank nominated in the credit as a negotiating bank, that has not

confirmed the credit, and that is also named in the credit as the
drawee bank for the purposes of the draft(s), faces an interesting set
of circumstances, particularly if the credit terms are at sight. Yes,
this would reflect poor issuance, yet it is not an unusual circumstance
today. The drawee bank may believe it is facing a conundrum: should
we negotiate or not? If we do, are we actually negotiating or are we
paying, since the draft is drawn on us? We did not confirm, so will we
have recourse or another right of recovery to the beneficiary if we are
not reimbursed? Recourse is an important, but not necessarily the
only basis for recovery. If the documents comply with the terms and
conditions of the credit, are we obligated to pay the beneficiary
because the sight draft is drawn on us? Surely, these are questions for
lawyers, not laymen practitioners!

Straight vs Negotiation Credits

Affording lesser protection to the beneficiary is the straight credit,
where the issuing bank instructs that documents are to be presented
to the issuer and a negotiating bank is not nominated. To be
protected, the beneficiary must have its complying documents at the
proper place by the proper date.

Intelligent beneficiaries read the letter of credit with special attention

to the engagement clause and look for answers to questions such
as: whose obligation is this? Where do I have to present my
documents, and by when?

An engagement clause might read:

We hereby engage with drawers, endorsers and bona fide holders of

drafts and complying documents drawn hereunder that the same will
be duly honored by us if negotiated on or before (this is the
archaic language);

or

We undertake with the beneficiary and nominated banks that

documents negotiated ;

or

We agree with you that documents strictly complying to the terms

and conditions of this credit will be honored by us if presented to us at
our office at (location) on or before (expiry date).

The first two are examples of negotiation engagement clauses, and

the third of a straight engagement clause. In a straight credit, the
obligation of the issuer runs directly to the beneficiary, and no bank is
nominated to negotiate documents. The experienced beneficiary
knows that, when in doubt, it should ask for clarity before
manufacturing and shipping the goods!
One often wonders why a beneficiary would agree to ship under a
straight credit. Even in this time of global overnight delivery services,
who can guarantee that documents will be received by the issuer at a
given location by a given date? Perhaps the straight credit is the
most compelling argument for using electronic presentation of
documents under the ICCs eUCP. This well-drafted, yet rarely
utilized, electronic supplement to UCP 500 first came into force on 1
April 2002. The eUCP was revised slightly to conform to the UCP 600
and the ICC Banking Commission approval of the UCP 600 included
approval of the revised eUCP.

Would the issuance of a straight credit preclude any bank from

negotiating (giving value) to the beneficiary for the documents? Of
course not! A bank may advance funds to its client against funds to be
received in the future. The difference lies in the protection offered to
the beneficiary. If the credit does not permit negotiation, the
documents must still reach the stated party by the date required by
the credit in order for the issuing bank to be obligated. Of course, a
bank that chooses to negotiate documents under this scenario would
prefer to be a nominated bank (rather than negotiating a straight
credit), thereby invoking the rights given to it under UCP 600.
Summary and conclusion

In negotiation, you advance funds to the beneficiary (or promise to do

so) against documents you believe to meet the terms and conditions of
the credit. A statement to the effect We will pay you when we receive
money from the issuing or reimbursing bank does not constitute
negotiation. Banks typically have negotiation agreements with
beneficiaries that spell out whether the negotiation is without
recourse to the beneficiary or with recourse. If with recourse, the
agreement spells out what the bank has recourse for: commercial risk
(for example, failure to receive reimbursement within YYY days from
the issuer), country risk or examination risk, such as a dispute with
the issuer over the compliance of the documents, etc.

I have seen many types of negotiation agreements. Some incorporate

language that warrants the beneficiary has presented documents to
the bank that conform to the credit in all respects; some make no such
representations; some request the negotiating bank to do a
superficial examination; some request an advance of funds from the
date of receipt by the negotiating bank, et al. They come in all shapes
and sizes.
Negotiation is a loan. A negotiation agreement is a lending document.
It spells out the terms of the loan, the conditions for repayment. The
latest draft of the UCP 600 revision has made a clear statement in this
respect.

There is hope for the salvation of the concept of negotiation for those
of us who have faith in the practice. Of course, faith is frequently
defined as a belief in things not seen, especially without logical proof.

A previous draft of this article appeared in DC Insight, Vol. 12, No. 3.