June 20 2008
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.
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.
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:
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:
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.
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