Back to the Basics: Honour, Negotiation, and Reimbursement of Letters of Credit

Honour, negotiation, and reimbursement – individually and collectively – are perhaps some of the least understood (or most misunderstood) terms in letter of credit practice. Some examples of mistaken notions include: (i) drafts to be drawn on negotiating bank; (ii) drafts to be drawn on issuing bank when LC is available with any bank by acceptance; (iii) confirming bank pays when payment is not made by the issuing bank at maturity; and (iv) nominated bank honours a sight payment LC when it pays the beneficiary from proceeds of a reimbursement claim. One can only wonder why misunderstanding is pervasive when these terms are so primary, core, and foundational to the essence of banks’ letter of credit business operations.

Definitions

The term ‘honour’ was incorporated in UCP600 (2007) as a short hand way to state what would otherwise require extensive phrasing and repetition throughout the rules.¹

It is defined in UCP600 Article 2 as:

The term ‘honour’ is used 30 times throughout UCP600 to express in short form the actions of the issuing bank, confirming bank, and nominated bank in relation to the definition provided.

The term ‘negotiation’ was first defined in UCP500 (1993), although use of the term and its permutations such as ‘negotiate’ and ‘negotiating’ have appeared since the first iteration of the rules in 1933 (UCP82). It is defined in UCP600 Article 2 as:

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 term ‘reimbursement’ is not formally defined in UCP600, but this term and ‘reimburse’ are used eight times in the rules to represent the undertaking of an issuing bank or a confirming bank to a nominated bank that has honoured or negotiated a complying presentation.² UCP600 Article 7(c) on the issuing bank’s undertaking states:

An issuing bank undertakes to reimburse a nominated bank that has honoured or negotiated a complying presentation and forwarded the documents to the issuing bank. Reimbursement for the amount of a complying presentation under a credit available by acceptance or deferred payment is due at maturity, whether or not the nominated bank prepaid or purchased before maturity. An issuing bank’s undertaking to reimburse a nominated bank is independent of the issuing bank’s undertaking to the beneficiary.

UCP600 Article 8(c) then states of a confirming bank’s undertaking:

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. Reimbursement for the amount of a complying presentation under a credit available by acceptance or deferred payment is due at maturity, whether or not another nominated bank prepaid or purchased before maturity. A confirming bank’s undertaking to reimburse another nominated bank is independent of the confirming bank’s undertaking to the beneficiary.