UAE Laws and Islamic Finance

Laws of the UAE and Islamic Finance

Archive for March 11, 2010

Documentary Credits in the UAE

 

1.

Definition and Scope

A documentary credit is a contract by which a bank opens a credit at the request of its customer (the party ordering the opening of the credit) up to a certain sum and for a certain period in favor of another person (the beneficiary) with the guarantee of documents that represent shipped goods or goods ready for shipment. 

The documentary credit contract is separate from the contract for which it is opened and the banks remain outside that contract.

Salient Features and Requirements

Every documentary credit must include a date for expiry of its validity and presentation of the documents for the purpose of settlement, acceptance, or discounting.

If the date prescribed for termination of the validity of the credit falls on a bank holiday, the validity period shall be extended to the first working day after the holiday.  Apart from holidays, the validity of a credit shall not be extended even if its date of termination coincides with an interruption of banking business due to force majeure unless specifically authorized by the orderer.

The documents against which the settlement, acceptance or discount processes are to be carried out must be accurately stated in the documentation pertaining to the request for the opening of, or endorsement or notification of the documentary credit.

The bank which opens the credit is bound to implement the agreed settlement, acceptance or discount terms in the credit contract if the documents representing the goods representing the goods correspond to the details and terms in that contract.

Types of Documentary Credit

A documentary credit may be revocable or absolutely irrevocable.  A documentary credit shall be absolutely irrevocable unless it is expressly agreed to be revocable.  A documentary credit may be divisible or transferable or indivisible or non-transferable.

Bank’s Obligations (Revocable Documentary Credit)

A revocable documentary credit shall not entail obligation of the bank to the beneficiary and the bank may at anytime amend or cancel it of its own initiative or at the request of the party who ordered the opening of the credit.

If the shipping documents are shipped in conformity with the details and terms in the documentary credit contract during its period and before it is concealed, the bank and the party who ordered the opening of the credit shall be jointly liable to the beneficiary.

Bank’s Obligations (Irrevocable Documentary Credit)

In the case of an irrevocable documentary credit, the obligation of the bank shall be absolute and direct to the beneficiary and to any bona fide bearer of the instrument drawn pursuant to the contract for which the documentary credit was opened.  A definitive documentary credit may not be canceled or amended with the consent of the all parties concerned.

Confirming Bank Obligations

A bank other than the one which opened the documentary credit may endorse an irrevocable credit by committing itself in turn absolutely and directly to the beneficiary and to any bona fide bearer of the instrument drawn pursuant to the contract for which the documentary credit was opened.

The mere forwarding of notice of the opening of a definitive documentary credit to the beneficiary via a bank other than the bank which opened the documentary credit shall not be deemed an endorsement of the credit by that other bank.

Duties of the Bank

If the documents are submitted to the bank after expiry of the credit period, the bank shall refuse them unless the party ordering the opening of the credit requests that they be accepted.

The bank must verify the existence of the required documents, that their contents conform exactly to the terms of the letter of credit, and that they are internally consistent.

The bank is obliged only to make a visual examination of the documents to ascertain that they correspond to the documents required in the letter of credit.  Verification of whether the goods themselves correspond to the documents which represent them lies outside the scope of the bank’s obligations.

If the bank accepts the documents it must pass them without delay to the party who ordered the opening of the credit.  If it refused them, it must forthwith notify the beneficiary of the documentary credit accordingly, stating the reasons for its refusal.

Transfer of Credit

The beneficiary may not transfer the credit in whole or in part to another person or other persons unless authorized to do so by the bank and unless there is express provision therefore in the letter of credit.

The bank may not sub-divide implementation of the credit unless there is specific authorization to do so by the party ordering the opening of the documentary credit.  Transfer may not be more than once unless otherwise provided for in the contract for the opening of the credit. 

Transfer shall be by endorsement of the letter of credit if to order or by taking receipt if to bearer.  If nominative, subrogation procedures must be obtained.

Obligations of the Applicant and Powers of the Bank

The party ordering the documentary credit is obliged to pay back to the bank the sum it has paid to the beneficiary up to the amount of the credit which has been opened.  He or she is also obliged to pay the expenses incurred by the bank in this regard.

As security for its entitlement, the bank may withhold the documents it has received from the seller and may also take a pledge over the goods represented by their documents.

If the party ordering the opening of the credit does not pay the bank the value of the shipping documents confirming the terms for the opening of the credit within one month from the date of his or her being advised of the arrival of the documents, the bank may sell the goods by following the method for enforcement against commercially pledged objects.  If the goods are destroyed or damaged, entitlement to pledge shall transfer to the amount of the bond.

Trust Receipts

Once the documents for the credit financed by the bank arrives, the bank and its customer may agree that the debtor customer shall renounce the goods which are the subject of the documentary credit or part thereof to the bank in settlement of the bank’s debt or some aspect of it and that the bank shall then authorize the customer to receive the goods on trust and sell on behalf of and on account of the bank on such terms and conditions as the two parties may agree.  In this case, the liability of the customer is that of a commission agent and the bank shall have the full rights of the principal over those goods and their proceeds.

*Emirates Institute for Banking and Financial Studies, Legal Environment in the United Arab Emirates, Laws Relating to Banking

2. 

“Establishing a documentary credit creates mutual obligations on the establishing bank and its customer, the applicant.  The bank becomes obligated to deliver the shipping documents to its customer, immediately upon receiving them, for the purpose of enabling the customer to take delivery of the consignment from the carrier.  The applicant, in turn, will be obliged to pay the value of the documentary credit in addition to all interest and expenses incurred by the bank in this respect.   Cassation Petition No. 120 of 2005 confirms the establishing bank’s right to exercise a lien over the shipping and other documents until it receives the value of the documentary credit and related cost from the applicant.  In practice, such payments are either made in cash or quite often by way of credit and debit entries pursuant to credit facilities arrangements.” (Omer Eltom)

The Commercial Transactions Law, Federal Law No. 18 of 1993 (the “Law”):

A documentary credit is an independent arrangement from the contract for which the credit was issued i.e. the issuing bank is under an obligation to pay the beneficiary regardless of the terms of the contract between the applicant and the beneficiary.  However, the issuing bank must ensure compliance of the terms of the documentary credit by the beneficiary before it may advance such funds to the Beneficiary. (Al Tamimi)

Article 428 of the Law:

  1. “The documentary credit is a contract according to which the bank opens a credit, at the request of its customer (orderer of the credit opening), within the limits of a certain amount and for a specified period, in favor of another person (the beneficiary), secured by documents representing the goods shipped or made ready for shipping.
  2. The documentary credit is considered independent from the contract for which it is opened and the bank shall remain independent of such contract.”

 

Each documentary credit must contain a maximum date within which the documents must be submitted by the Beneficiary.

Article 429 of the Law:

“Each documentary credit must have a maximum date for its validity and for the provision of the documents for the purpose of payment acceptance or deduction.  However, if the date specified for expiry of the validity of the credit coincides with the banks holiday, the validity period shall be extended to the first working day following the holiday.  Except for holidays, the credit validity shall not be extended even if its date of expiry coincides with stoppage of banking activity due to force majeure unless there is an explicit authorization to this effect from the orderer.”

Documents required to be submitted by the beneficiary must be defined clearly and the issuing bank has an obligation to ensure that documents presented by the beneficiary correspond exactly to the documents required under the documentary credit.  (Al Tamimi)

Article 430 of the Law:

  1. “Papers related to an application for the opening, confirmation or notification of a documentary credit must specify precisely the documents against which payment, acceptance, or deduction shall be effected.
  2. The bank opening the credit shall fulfill the conditions of payment, acceptance and deduction agreed upon in the credit contract if the documents representing the goods are in accordance with the conditions and details contained in the said contract.”

 

A documentary credit may  be revocable or irrevocable.  In the absence of such indication, the documentary credit would be irrevocable. 

Article 431 of the Law:

  1. “A documentary credit may be revocable or conclusively irrevocable.
  2. A documentary credit shall be irrevocable unless its irrevocability is expressly agreed upon. 
  3. A documentary credit may be divisible, transferable, indivisible, or untransferable.”

 

 Article 432 of the Law:

  1. “A revocable documentary credit shall not involve any liability by the bank towards the beneficiary and the bank may at anytime amend or revoke such credit on its part or at the request of the person who orders its opening.
  2. If shipping documents are submitted in accordance with the terms and conditions of the documentary credit contract and within the stated period as well as prior to its cancellation the bank and the person who has ordered the opening of the credit shall be jointly liable to the beneficiary.”

 

A bank may not, in the case of an irrevocable documentary credit withdraw or cancel the credit.  Furthermore, such documentary credit may not be amended or withdrawn without the agreement of all the relevant parties. 

Article 433 of the Law:

  1. “In the case of an absolutely irrevocable documentary credit, the bank’s liability shall be conclusive and direct towards the beneficiary as well as towards any bona fide holder of the document drawn in implementation of the contract due to which the documentary credit has been opened.
  2. A conclusive documentary credit may not be revoked or amended except by agreement of all parties concerned.”

 

A documentary credit is usually used to finance international trade.

Article 434 of the Law:

  1. “Any bank other than that which has opened the documentary credit may confirm the conclusive and irrevocable credit by being in turn firmly and directly liable towards the beneficiary as well as towards any bona fide holder of the drawn document, in implementation of the credit opening contract.
  2. The mere advice of the opening of the conclusive documentary credit sent to the beneficiary through a bank other than that which has opened the documentary credit shall not be considered as confirmation of the credit by the other bank.”

 

However, if the other bank’s duty is restricted to notifying the beneficiary of the credit, in thsi case the notifying bank will not be liable toward the beneficiary.  (Al Tamimi)

Article 435 of the Law:

  1. “The documents shall be submitted to the bank prior to the expiry of the period of the credit; however, if they are submitted thereafter, the bank shall reject them unless the credit opening orderer requests their acceptance and the bank approves such request.
  2. The bank shall insure that the required documents are available, that their contents are exactly in accordance with the conditions of the letter of credit, and that they correspond with each other.” 

 

Banks are not required to examine any document other than the documents presented to them by the beneficiary.  Furthermore, banks are not under any obligation to check whether such documents represent the goods in question or not.   The bank’s obligation is confined to ensuring that the presented documents are the exact documents required under the documentary credit.  (Al Tamimi)

Article 436 of the Law:

“The bank shall only be responsible for checking the documents and ensuring that they are prima facie in accordance with the documents required in the letter of credit.  However, verification of the compliance of the goods themselves with the documents that they represent is outside the scope of the bank’s responsibility.”

The accepting bank must forward the documents received from the beneficiary to the applicant as soon as possible. 

Article 437 of the Law:

“If the bank accepts the documents, it shall urgently transfer them by the orderer of the credit opening; and if it rejects them, it shall immediately notify the beneficiary of the documentary credit to this effect showing reasons for such rejection.”

A beneficiary may not transfer or assign the credit or any part thereof to any person unless the beneficiary is authorized to do so according to the terms of the credit.  (Al Tamimi)

Article 438 of the Law:

  1. “The beneficiary may not transfer the credit in whole or in part to another person or other persons unless he is authorized to do so by the bank and unless it is expressly provided for in the letter of credit.
  2. The bank may not divide implementation of the credit unless the orderer authorizes it do so.
  3. The transfer may not be made except once unless otherwise provided for in the credit opening contract.
  4. The transfer shall be made by endorsing the letter of credit if it is promissory, or by receiving it if it is to be bearer, but if it is nominal, remittance procedures shall be followed.”

 

Article 439 of the Law:

  1. “The orderer of the opening of a documentary credit shall undertake to return to the bank the amount paid to the beneficiary within the limits of the opened credit and shall undertake to pay to the bank the expenses, which may have been incurred thereby in this respect.
  2. As guarantee to its dues, the bank shall have the right to foreclose the documents received by it from the seller and shall have mortgage right on the goods represented by their documents.
  3. If the orderer of the opening of a credit fails to pay to the bank the value of the bills of lading that are in conformity with the credit opening conditions within one month from the date of being notified of the arrival of such documents, the bank shall sell the goods by following the methods of execution on commercially mortgaged things.
  4. If the goods are destroyed or if they deteriorate or become damaged, the right of mortgage shall pass to the insurance amount.
  5. However, after arrival of the documents of credit financed by the bank, the bank and its customer may agree that the indebted customer may assign to the bank the goods, subject of the documentary credit, or any part thereof in settlement of the bank’s debt or part thereof and hence the bank shall entrust the customer with taking delivery of such goods on a trust basis and sell them on behalf of the bank and to its account under such terms and conditions as agreed upon by both parties; and the customer’s responsibility, in this case, shall be that of the commission agent and the bank shall have all the rights of the principal on such goods or their value.”

 

According to Omer Eltom, Cassation Petition 278 of 2003 Dubai Supreme Court held that these provisions are complementary to the intentions of the parties and that the parties may exclude them by agreement and instead adopt the Uniform Rules and Practices of Documentary Credits issued by the International Chambers of Commerce.  In documentary credit agreements, the parties are therefore free to include any terms and conditions regarding the mode of payment and the documents which should be presented.  Cassation Petition 478 of 2004 held that:

“The provisions relating to documentary credits contained in section 4 of chapter 3 of the Code of Commercial Transactions are not mandatory rules but are rather complementary to the parties’ intentions.  The parties to a documentary credit transaction may instead agree to apply the Uniform Rules and Practices for Documentary Credits issued by the International Chamber of Commerce

 (http://en.wikipedia.org/wiki/Uniform_Customs_and_Practice_for_Documentary_Credits)

in respect of all disputes, pursuant to Article 2 of the Code of Commercial Transactions.  In any event, documentary credits under the Uniform Rules and Practices are subject to the mutual consent of the parties which may incorporate any terms or conditions regarding the mode of payment and the documents which should be presented.  Once approved by the parties, such terms and conditions become binding upon them.”

Where the ICC Uniform Rules and Practices are applicable, the obligations and rights of an establishing bank are stated in Dubai Supreme Court’s Judgment in Cassation Petitions 98 of 2004 and 152 of 2004:

“A documentary credit is a contract enabling a bank to establish a credit, upon the request of its customer (the applicant), for a specified sum of money and specified period in favor of another person (the beneficiary) secured by documents which represent a cargo that is shipped or being prepared for shipment.  Such a contract is independent from the contract for which the documentary credit is established and in respect of which the bank remains an alien … The documents presented to the bank should comply with the requirements of the documentary credit i.e. should be fully compliant.  The bank’s obligation is restricted to examining the documents with reasonable care for the purpose of ascertaining that they do, on the face of it, comply with the terms and particulars contained in the documentary credit.  If the bank is of the opinion that the documents do not comply it may reject them.  It may also send them to its customer for approval as soon as possible.  Otherwise, the bank will be deemed to have accepted the documents and will be liable to pay accordingly, in which case it may not also be able to recover from its customer what it has paid to the beneficiary.  However, if no objection is raised by the applicant or if he accepts the documents delivered by the establishing bank, the bank may recover the money it has paid to the beneficiary.”

Bouncing A Security Check Does Not Give Rise to Criminal Recourse in the UAE

 

 

A check is a payment instrument rather than a credit/security instrument.  It is an unconditional order to pay a certain sum of money on a specified date to the order of a certain person or to bearer.  If it is obtained as a security instrument payable under certain conditions (conditional order), it will be converted into a mere payment order/bill of exchange because it will lack its main characteristic of being an unconditional order and mode of payment instrument rather a credit (security) instrument.  Such kind of instrument shall not deprive its holder from having a civil recourse against the drawer based on the fact that it is converted into a bill of exchange or mere payment order, but it shall deprive the holder from having the right of a criminal recourse since it shall no longer be a check.  Any exercise of a criminal recourse by the holder if the check is dishonored for lack/insufficiency of funds shall be unlawful and the holder may be liable in damages.

*Emirates Institute for Banking and Financial Studies, Legal Environment in the United Arab Emirates (Laws Relating to Banking)

UAE Laws and Islamic Finance

Laws of the UAE and Islamic Finance