Transfer versus Assignment
Types of Assignment
Article 39 of the Seventh Revision of Uniform Customs and Practice for Documentary Credits (UCP 600) on assignment of proceeds retains the wording of Article 49 of UCP 500. UCP 600 provides that, to the extent that it is permissible under the applicable law, a beneficiary is entitled to assign the letter of credit proceeds even if the letter of credit is not transferable. However, UCP 600 remains silent on the differences between a transfer and an assignment.
Transfer versus Assignment
An assignment of letter of credit proceeds is an assignment (or transfer) of future debt payable under a letter of credit from the beneficiary to another person (ie, the assignee). It enables the assignee, instead of the beneficiary, to receive payment under the letter of credit. An assignment of proceeds does not convey a right to draw or to perform under the letter of credit; the drawing must be made by the named beneficiary, although the right to receive the proceeds is vested in the assignee.
In contrast, when a letter of credit is transferred to the transferee, the right to draw or to perform under the letter of credit is also transferred. The transfer of a letter of credit allows a second beneficiary (ie, the transferee) to present documents pursuant to the letter of credit and so be paid.
Thus, the role of an assignee under an assignment is relatively passive because, as far as letter of credit payment is concerned, an assignee must wait until the letter of credit proceeds emerge, whereas a transferee can take an active role to draw on the letter of credit.
As UCP 600 neatly sets out the way in which a letter of credit may be transferred, this update focuses on the legal aspects of the assignment of letter of credit proceeds.
Letter of credit proceeds are commonly assigned by way of purchase and by way of security.
Assignment by purchase
This takes the form of a true sale and purchase transaction between the letter of credit beneficiary and the assignee. The assignee is effectively purchasing the debt (ie, the receivables under the letter of credit) from the beneficiary. As a result, the letter of credit proceeds, once assigned, are the property of the assignee.
Although the assignment of the letter of credit proceeds is by way of purchase, it can still be structured so that the purchase is with recourse to the letter of credit beneficiary on the occurrence of certain events (eg, the insolvency of the issuing bank).
Assignment by security
This takes the form of collateral for a loan. The assignee advances funds to the letter of credit beneficiary and takes the letter of credit proceeds as security backing such advances. The proceeds remain the property of the beneficiary, but are subject to the security interest of the assignee.
Types of Assignment
No matter how the assignment is effected, it can be classified as either a legal assignment or an equitable assignment.
A legal assignment must be:
- in writing;
- absolute - that is, it must assign all of the interests under the letter of credit; and
- confirmed by a notice of assignment served on the letter of credit obligor (eg, the issuing bank).
An assignment which does not satisfy all three criteria is an equitable assignment.
An assignee under a legal assignment will be entitled to sue the letter of credit obligor in its own name. However, under an equitable assignment, the assignee will have to join with the letter of credit beneficiary to take legal action against the obligor as co-plaintiff or, if the beneficiary refuses to sue the obligor jointly with the assignee, to sue the beneficiary as co-defendant together with the obligor when the latter defaults in payment. This explains why banks generally prefer to obtain legal rather than equitable assignments.
Is registration required for assignment?
If an assignment is obtained by way of purchase, no registration of the assignment is required under Hong Kong law, as the proceeds are no longer the property of the letter of credit beneficiary. However, if the assignment is obtained by way of security, the registration requirement will apply. Failure to register a registrable assignment will render the assignment void against the liquidator and creditors of the letter of credit beneficiary.
Must notice of assignment be served on the issuing bank?
If a letter of credit is silent on whether the proceeds may be assigned by the beneficiary to a third party, the presumption is that assignment of the proceeds is permissible. Under Hong Kong law, if the assignment of letter of credit proceeds is not prohibited, the assignee is not obliged to give notice of assignment to the obligor in order to render the assignment legally valid and enforceable. However, failure to serve a notice of assignment on the obligor may lead to the following consequences:
- The assignee has no right to sue the obligor in its own name because the assignment is an equitable assignment;
- In the absence of a notice of assignment, the obligor obtains good discharge by effecting payment to the beneficiary, even if the beneficiary subsequently fails to pass the proceeds to the assignee;
- If the beneficiary fraudulently assigns the proceeds to more than one assignee, the assignee that first serves a notice of assignment on the obligor will have priority; and
- The cut-off of set-off rights between the obligor and beneficiary is generally prevented by the letter of credit autonomy principle. However, in an open account sale and purchase transaction, a notice of assignment will cut off the debtor's set-off rights against the seller. Thus, from the time the notice of assignment is duly served on the debtor, the debtor will not be entitled to offset the sales proceeds against any debt owed by the seller to the debtor. This is critical in accounts receivable financing transactions.
Must acknowledgment of the notice of assignment be obtained from the obligor?
Under Hong Kong law, unless the letter of credit provides otherwise, no consent from the obligor is required for assignment of the proceeds; therefore, no acknowledgment of the obligor signifying its consent to assignment is strictly necessary for the fulfilment of the assignment. However, acknowledgment of the notice of assignment gives the assignee additional benefits because it represents proof that notice was duly served on the obligor. In daily banking practice, if a notice of assignment is successfully sent by way of an authenticated Society for Worldwide Interbank Financial Telecommunication message, an 'acknowledge' code signifying that the notice has been duly served on the obligor will automatically be generated, in which case a separate acknowledgment from the obligor is not needed.
An assignee of letter of credit proceeds takes a passive role in receiving the monies under the letter of credit, whereas a second beneficiary under the letter of credit takes an active role in drawing it.
Assignment of letter of credit proceeds can be effected by way of purchase or by way of security; in the latter case, registration is required under Hong Kong law to ensure the priority of the assignment.
For further information on this topic please contact Fung King Tak at DLA Piper Hong Kong by telephone (+852 2103 0808) or by fax (+852 2810 1345) or by email (email@example.com).
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There are three main ways that a beneficiary of a Documentary Letter of Credit (DC) can use the original DC to pay suppliers using the DC itself.
The first is to ask a bank to issue a Back to Back DC using the original DC as collateral. This method has in the past, unfortunately, been shown to be vulnerable to fraudulent trading, and so now banks will rarely agree to cover the risk.
The second is to obtain a Transferable DC. If the supplier and all banks involved in the transaction agree, it is possible for the original beneficiary to request that the bank at which the DC is available, to transfer part of the value of that DC to the supplier (always known as the second beneficiary). It is possible for the original beneficiary to transfer to more than one supplier, but the total sum transferred must not exceed the value of the original DC. One of the main problems with this method is that in some countries, their fiscal policies do not allow DC’s originating from those countries to be transferable.
Assignment of Proceeds
The third way that a DC beneficiary can use a DC to pay suppliers is through an Assignment of Proceeds. In UCP 600, this is covered by Article 39 which merely states that the beneficiary has the right to assign any proceeds from the DC to which they are entitled.
The procedure is as follows:
1. Beneficiary receives a workable Documentary Credit. They contact the negotiating bank and request that the bank send an irrevocable instruction in letter form to the supplier. This letter will tell the supplier that the bank has received notification from the beneficiary to make the relevant payment to the supplier out of the credit proceeds. The bank will charge the beneficiary a fee for this service.
2. The beneficiary must advise the negotiating bank whether any bank charges should be taken from this payment. The usual instruction is that all bank charges for the transaction should be borne by the beneficiary and that the supplier receives the full value of the agreed reimbursement (less any charges from their own bank, if applicable).
3. Once this letter has been issued it is irrevocable and the funds will be transferred once the DC is successfully negotiated. However, please note that the bank will not undertake any payment or guarantee towards the supplier: the bank is only acting as an agent for the payment of funds received from the negotiation of the DC.
There are a number of factors which need to be taken into consideration with an Assignment of Proceeds. First, national law will determine the extent and legal affect of the assignment. Secondly, any payment made to a supplier using this method is wholly dependent on the beneficiary of the DC submitting conforming documents on presentation. Thirdly, the bank cannot pay the supplier if they don’t have free use of the proceeds received from the DC. Fourthly, it is much safer if the DC being negotiated is a confirmed one and this is a question that the supplier will need to ask the beneficiary prior to accepting Assignment of Proceeds.
The benefits to the supplier, however, is that they have no additional costs to pay in either bank charges (unless otherwise agreed) or time and that once the DC is successfully negotiated, they will receive payment within the agreed time limits of the DC itself.
Maria Narancic from Point to Point Export Services is an independent international trade adviser who assists organisations world wide with their international trade projects, documentation, Documentary Credits and import/export training. She is based in the United Kingdom. If you require any further assistance with the matters mentioned above, please do contact us by e-mail on firstname.lastname@example.org or check out other articles on International Trade on the Point to Point Export Services website at www.point-point.com