Bills of Exchange, Promissory Notes and Other Independent Payment Undertakings

Presentations by Simon Cook and Sam Fowler-Holmes

Sullivan & Worcester UK LLP

on 27 July 2017

At Pinners Hall, 105-108 Old Broad Street,

London, EC2N 1EX

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What this talk will cover Introduction to Bills of Exchange (BoEs) and Promissory Notes

(PNs)

The legal requirements

Negotiability

Key issues to be aware of

Independent payment undertakings from obligors

Some possible scenarios for BoEs, PNs and IPUs

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Introduction

Both BoEs and PNs are independent payment undertakings

They embody a debt due by one person to another

Historical origins in both domestic and international trade

› Now used principally in cross-border trade transactions

› But can be used as a method of financing

English law requirements set out in Bills of Exchange Act 1882 (the

Act) as developed by English case law

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BoEs – example structure

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Seller (payee and first holder) Buyer (drawer)

Delivers bill

Sells goods for payment in 6 months

Bank (drawee and acceptor)

Presents bill for payment

Draws bill

Agrees to provide buyer with a line of credit and accepts bill drawn by buyer

Payment

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Statutory definitions “A bill of exchange is an unconditional order in writing, addressed

by one person to another, signed by the person giving it, requiring the person to whom it is addressed to pay on demand or at a fixed or determinable future time a sum certain in money to or to the order of a specified person, or to bearer.” (section 3(1) of the Act)

“A promissory note is an unconditional promise in writing made by one person to another signed by the marker, engaging to pay, on demand or at a fixed or determinable future time, a sum certain in money, to, or to the order of, a specified person or bearer.” (section 83(1) of the Act)

Unconditional order vs unconditional promise

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The legal requirements (1) Differences exist between BoEs and PNs but both are subject to the

same core requirements under the Act: › the instrument must contain an unconditional order (in respect of a BoE) or

unconditional promise (in respect of a PN); › it must be in writing; › it must be addressed by one person to another; › it must be signed by the drawer (in respect of a BoE) or the maker (in respect of

a PN); and › it must require the drawee (in respect of a BoE) or the maker (in respect of a PN)

to pay: on demand or at a fixed or determinable future time; a sum certain in money; and to, or to the order of, a specified person or to bearer.

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The legal requirements (2) Unconditional order or promise

“At 12 months I promise to pay A and B £500, to be held by them as collateral security for any moneys now owing to them by J.M., which they may be unable to recover on realising the securities they now hold and others which may be placed in their hands by him” (Robins v May (1839)

› Instruments payable on a contingency (e.g. I will pay subject to A putting me in funds) will not satisfy requirements

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The legal requirements (3) In writing and signed by the drawer / maker

› Previously considered that this meant you had to have a physical document › Supported by a Law Commission paper from December 2001 which took the

view that the requirements of the Act could not be satisfied electronically and absence of statutory instrument under the Electronic Communications Act 2000

› Case law focussed on whether a proposed ‘signature’ was adequate › However, 2016 practice note from a joint working party of the Law Society

prepared with leading counsel (JWP) takes the view that statutory requirements for a document to be in writing and signed can be satisfied electronically

› JWP expressly refer to section 83 of the Act relating to promissory notes › JWP’s view formed on basis of the Interpretation Act 1978 and recent case law

regarding use of electronic signatures (Golden Ocean Group Limited v Salgaocar Mining Industries PVT Ltd and another [2012] and J Pereira Fernandes SA v Mehta [2006])

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The legal requirements (4) In writing and signed by the drawer / maker (cont.)

› JWP do not consider the implications of their conclusion further in respect of BoEs or PNs

› Despite JWP’s view, there are a number of issues with electronic BoEs and PNs that continue to cast doubt on their feasibility:

› What is the original instrument? › How are endorsements added? › How is the instrument presented for payment? › Protesting? › Double-selling

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The legal requirements (5) Time for payment

› Likely to be unproblematic where on demand or fixed date › Careful drafting needed where instrument payable at a “determinable future

time” – if this relies on the occurrence of a specified event, this must be certain to happen

› The more certainty the better – for example, Court of Appeal held that a PN payable “on or before” a fixed date did not satisfy the requirements as to time of payment (Williamson v Rider [1963])

Sum certain › Amount due under the instrument must be clear on its face › Interest can be charged on the amount specified in the instrument provided (a) it

is ascertainable and (b) the period that interest is payable for is certain Fixed rate interest acceptable Floating rate interest by reference to specified rate (e.g. LIBOR)?

› Default interest covered in the Act

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Independence of BoEs and PNs Independence of BoEs and PNs is a fundamental characteristic

Rights and obligations of the parties to the instrument are independent and separate from any underlying transaction – distinguishes these instruments from surety or accessory style instruments (e.g. English law guarantees)

Generally viewed as being favourable to the holder as prevents liable party from relying on defences or provisions it would otherwise have the benefit of in the underlying transaction documentation

However applies both ways so must ensure instrument covers all relevant matters › interest › immunity

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Negotiability (1) BoEs and PNs are both negotiable instruments (subject to no

restriction included in such instrument)

This means they are instruments that can be transferred: › By delivery (where issued to bearer) › By delivery and endorsement (where issued to, or to the order of, a

specified person)

AND › Which transfer absolute title in that instrument › Free from any defects in title the transferor may have

However, only a “holder in due course” will obtain such rights

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Negotiability (2) A holder in due course is a transferee who:

› has taken a bill, complete and regular on the face of it › became the holder of it before it was overdue › had no notice that it had been previously dishonoured › took the bill in good faith and for value › had no notice of any defect in the title of the person who negotiated it

The holder in due course has the right to pursue any other person before him liable on the instrument (e.g. acceptor, drawer and any indorser) › In practice any such liability will usually be removed by “without recourse”

indorsements

A holder other than a holder in due course still has right to sue but takes subject to equities and defects in title and may have additional requirements to satisfy

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Delivery Delivery has to take place to complete a contract under a BoE or

PN

Without delivery, there is no issue of the BoE or PN

Drawing or making of BoE or PN, acceptance and indorsement all require delivery – contract is incomplete and irrevocable until delivery

However, an acceptor who notifies the payee of his acceptance will be irrevocably bound at that point

Delivery can be actual or constructive (by way of attornment)

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Indorsement Indorsements must be in writing and signed by the indorser

Indorsement must be written on the instrument

Indorsement on a copy of the instrument (or allonge) acceptable where instrument issued or negotiated in a jurisdiction that recognises copies

Must be for full amount of the instrument

Can be with or without recourse – hallmark of forfaiting transactions is “without recourse” nature of indorsement

Indorsement can be to a specified person (or to their order) or to bearer

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Presentation for payment Generally the acceptor of a BoE and a maker of a PN are liable on

the instrument without presentation unless the instrument specifically states payment is to be made at a specific place and in respect of a BoE there and that place only

Presentation is generally needed in order to render the drawer of a BoE or an indorser of a BoE or PN liable

However, presentation normally carried out, especially where dealing with parties in other jurisdictions

Presentation should be on the relevant date of maturity for instruments with fixed determinable future dates. When instrument is on demand, presentation must be within a reasonable time of issue (for BoE only) or indorsement in order to render the drawer or indorser liable.

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Payment and dishonour Common for instruments to be expressed to be payable at payer’s

bank › No obligation for bank to make payment without something further to this effect › But, fact of making instrument payable at bank is sufficient authority for bank to

make payment (Kymer v Laurie [1849])

Payment can be made to a person acting on behalf of the holder (eg a collecting bank) provided the holder treats such payment as discharging the payer’s liability

Payment must be in legal tender unless otherwise agreed

Instrument is dishonoured where it is presented and not paid (actual dishonour) or excused from presentation and “overdue and unpaid” (deemed dishonour) › Unclear what is meant by overdue and unpaid, particularly in context of on

demand instruments

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Notice of dishonour Where an instrument has been dishonoured by non-payment,

notice of dishonour must be served on the drawer (for BoEs) and any indorsees

Failure to give notice of dishonour will discharge the relevant drawer or indorsee subject to certain limited exceptions

Notice of dishonour must be given within a “reasonable time” of dishonouring (section 49(12) of the Act)

Where instrument is in the hands of an agent when dishonoured (eg collecting bank), agent can either give notice of dishonour to other parties or must give notice of dishonour to principal in same way as if the agent were a holder

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Protesting Protesting is a formal method of documenting that a BoE or PN has

been dishonoured

As with notice of dishonour, it’s purpose is to ensure the holder maintains any right of recourse he may have against the drawer of a BoE or any indorser of an instrument

Under the Act, protest is only required for “foreign bills” and not for “inland bills” or for PNs › A foreign bill is any bill that is not an inland bill › An inland bill is a bill that is or purports to be drawn and payable in the British

Isles

However, protesting is a mandatory requirement in a number of jurisdictions (and is provided for under the 1930 Geneva Convention) and it may therefore be necessary to protest to retain rights under the instrument in other jurisdictions

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Avals and bank guarantees BoEs and PNs may be supported by a bank guarantee or ‘aval’ for

credit enhancement

Where a separate bank guarantee is used, consideration needs to be given to how the benefit of this can be transferred to subsequent holders

Avals are a creature of civil law jurisdictions and are not expressly recognised under English law

English courts have tended to construe an aval as a voluntary with recourse indorsement

The aval must be on the instrument, signed by the avaliser with appropriate wording (often ‘bon pour aval’) added

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CRR and negotiable instruments (1) Independent payment undertakings such as SBLCs and demand

guarantees could be used as credit risk mitigation (CRM) for the purposes of calculating capital requirements under EC Regulation (EU) No 575/2013 (the CRR) where they relate to an underlying exposure.

Similar analysis should apply to BoEs and PNs

“unfunded credit protection” means a technique of credit risk mitigation where the reduction of the credit risk on the exposure of an institution derives from the obligation of a third party to pay an amount in the event of the default of the borrower or the occurrence of other specified credit events (Article 4(59) CRR).

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CRR and negotiable instruments (2) BoEs and PNs are not expressly listed as an eligible protection agreement

for unfunded credit protection › “Guarantees” are eligible - No definition of what is meant by “guarantee”, but

reasonable to conclude that not limited to English law guarantees in the strict legal sense

› BoEs and PNs can effectively function like guarantees where supporting underlying obligations (e.g. a parent issuing a PN in respect of obligations of a subsidiary under finance documents)

Key criteria for guarantees (not exhaustive): › “direct” obligation of the issuing bank (or equivalent party) to pay the

beneficiary on occurrence on certain events, which should include the default of the underlying obligor

› “clearly defined and incontrovertible” › must not contain any clause of provision, the fulfilment of which is outside the

direct control of the beneficiary, that would: allow the issuing bank to cancel unilaterally; increase the cost of the protection; and/or prevent the issuing bank from paying out in a timely manner

Conflict of laws issues when satisfying requirement for CRM to be enforceable in all relevant jurisdictions

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Key issues (1) Governing law and jurisdiction

Common for BoEs and PNs not to contain a governing law clause or a jurisdiction clause

These instruments constitute a chain of contracts and it is recognised that there may be a different governing law for each contract

How to determine what the governing law is? › Section 72 of the Act provides some limited statutory guidance › Focusses on place contract was formed › Contrast with 1930 Geneva Convention for settlement of certain conflicts of laws

in connection with BoEs and PNs

Matters not covered by the Act decided on common law principles

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Key issues (2) Governing law and jurisdiction (cont.)

Different courts will apply different conflict of laws tests so may get a different answer depending on which court is deciding the matter

Express governing law clause › No reason why this cannot be included › Would bind the initial contracting parties › Query whether this would bind subsequent parties both as against acceptor/

maker and as against intermediate parties

Use of side letters to select governing law › Acceptor or other liable party may agree that both the side letter and the

instrument are governed by specific law › Arguments for and against efficacy of the side letter › Transferability of letter for subsequent holders

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Key issues (3) Capacity and authority of parties

› If a party has no capacity or authority then it will not be liable unless it is subsequently ratified

› However, section 54 of the Act states that the acceptor is precluded from denying the capacity and authority of the drawer as against a holder in due course

› In respect of other parties, the incapacity of one party in the chain will not invalidate the instrument as against the other parties in the chain

Authenticity of signatures › No party is bound on an instrument unless he has signed it knowing what the

instrument was › Agents may sign on behalf of their principal but must be clear that they sign in

capacity as agent › An acceptor is precluded from claiming that the drawer’s signature was forged as

against a holder in due course › A party has no liability where his signature is forged. However, a subsequent

indorser can not defend a claim for payment on the basis of the genuineness of prior signatures

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Other independent payment undertakings (1)

Diverse range of other forms of independent payment undertakings (IPUs) (letters of credit, SBLCs, demand guarantees)

Focus on IPUs issued by the underlying obligor to support an existing obligation

IPUs share the same benefits of independence as for PNs and BoEs

May be used for particular financing structures or where obligor cannot or will not issue a BoE or PN

However, these are not negotiable instruments

Transfer of benefit of IPU should be covered

While not negotiable instruments, contrast with contract receivables

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Other independent payment undertakings (2)

Contract receivables: › Generated by commercial contract › Seller might deliver invoices for each delivery › Not independent from underlying transaction – buyer may have

contractual defences to payment that should not apply to an IPU › Contracts can be entered into and invoices can be issued electronically

Transferability of contract receivables: › Legal or equitable assignment › Under English law, requirements of The Law of Property Act 1925 must

be satisfied for a legal assignment › Silent or disclosed assignment - notice to debtor? › Possible to assign future receivables under English law

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Example scenarios (1) Promissory notes

These are often used as a ‘guarantee’ (in the non-legal sense) of an existing obligation

For example, PNs issued by a borrower in respect of obligations arising under finance documents

May have practical benefits in other jurisdictions where PNs given more favourable treatment in making claims against obligor

Practical issues regarding presentation where sum certain is more than outstandings › Present for full amount with requirements to account for surplus › Amend PN on each repayment › Replacement PN issued for new sum certain after each repayment

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Example scenarios (2) Bills of exchange

Can be used as a method of payment (see previous diagram)

Bills can be drawn on the buyer or, to improve credit risk, can be drawn on the buyer’s bank

Bills can be used within acceptance credits as an alternative to deferred payment letters of credit › Letter of credit is honoured by acceptance of a time bill of exchange by issuing

bank or confirming bank › Accepting bank’s liability under the letter of credit is replaced by its liability

under the accepted bill of exchange › The beneficiary can sell the accepted bill of exchange in order to get paid before

maturity – this should be more easily achieved than having to discount a deferred payment letter of credit

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Example scenarios (3) IPUs

Can be used in a wide range of scenarios where the obligor has an underlying payment obligation

Common example is in buyer led supply chain finance structures

However, can be used in more complex transactions: › Participation arrangement relating to an underlying receivables purchase

agreement › Participant was originally named as loss payee but this did not provide capital

relief for exposure › Insurers agreed to provide co-assurance for participant alongside grantor (being

purchaser under the RPA) BUT would not include non-vitiation language › Participant subject to risk of breach by grantor taking policy off risk › This risk was mitigated by grantor providing an independent payment

undertaking in participation agreement in respect to any amount not paid by insurers due to grantor breach

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Questions?

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Future dates for your diary:

Breakfast seminars 2017

28 September 2017 26 October 2017

23 November 2017 14 December 2017

Anniversary Party 16 November 2017

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Simon Cook Partner

Simon Cook is a partner in the Trade & Export Finance Group in our London office. He has experience in a wide variety of banking and finance transactions, including in particular in relation to structured trade finance, trade finance, project finance, invoice discounting facilities and borrowing-base facilities in Africa, the Middle East, Asia and the CIS. His work in the structured trade area covers a range of pre-export and prepayment financings acting for both lenders and borrowers notably in oil, telecoms, soft commodities and metals sectors with particular experience in Africa and the Middle East.

Simon has worked and travelled extensively in Africa and the Middle East, having spent over three and a half years in Dubai. He has participated in a number of structured trade finance and project finance conferences and seminars throughout Europe, the Middle East and Africa, including speaking at conferences on PPP in South Africa; on project finance and structured trade finance at Afrexim's annual structured finance conferences in Egypt, Ghana, Zambia and South Africa; and at structured trade finance seminars and general finance in London, Paris, Lisbon, Geneva, Frankfurt, Amsterdam, South Africa, Zambia, Uganda, Ghana, Nairobi and Dubai.

Sullivan & Worcester UK LLP Tower 42 25 Old Broad Street London EC2N 1HQ

T +44 (0)20 7448 1002 F +44 (0)20 7900 3472 scook@sandw.com

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Sam Fowler-Holmes Associate

Sam Fowler-Holmes is an associate in the Trade & Export Finance team. He specialises in structured and unstructured trade finance and has advised financial institutions on a range of products including large-scale pre-export financing, supply-chain financing, funded and risk participations, and bank-to-bank lending. Sam's experience includes advising in relation to numerous jurisdictions across mainland Europe, CIS, Africa and Asia and for a range of commodities including, oil, gas, metals and cocoa.

Sullivan & Worcester UK LLP Tower 42 25 Old Broad Street London EC2N 1HQ

T +44 (0)20 7448 1006 F +44 (0)20 7900 3472 sfowlerholmes@sandw.com

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Awards & Recognition TFR “Best Law Firm in Trade Finance”

Trade & Forfaiting Review (TFR) named Sullivan & Worcester "Best Law Firm in Trade Finance" in its 2014, 2015 and 2016 TFR Excellence Awards GTR “Best Law Firm Poll”

Sullivan & Worcester UK LLP was top ranked firm in the Global Trade Review (GTR) Best Law Firm 2015 and 2016 polls The Legal 500 UK 2016

Geoffrey Wynne and Simon Cook are listed as Leading Lawyers and Sullivan & Worcester UK LLP was ranked in the following category in The Legal 500 UK:

› Trade Finance (Tier 1) Chambers UK 2016

Chambers UK ranked Sullivan & Worcester UK LLP, along with Geoffrey Wynne and Simon Cook, in the following area:

› Commodities: Trade Finance (UK-wide)

TFR Fellowship Award 2017

Trade & Forfaiting Review (TFR) honoured Geoffrey Wynne with the TFR Fellowship Award in its 2017 TFR Excellence Awards

www.sandw.com

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