Facts: Discharge and release of cargo without OBLs 

Valency International Pte Ltd (“Valency”) provided letter of credit (LC) financing to K.I. (International) Limited (“Kamachi”) for Kamachi’s purchase of 55,000 metric tonnes (MTs) of steam coal from JSW International Tradecorp Pte Ltd (“JSW”). The cargo was shipped from South Africa to Krishnapatnam port in India on the MV Stella Cherise (the “Vessel”), and 22 BLs were issued in its respect. JSW had chartered the Vessel from Oldendorff Carriers GmbH & Co KG (“Owners”), and requested Oldendorff to nominate Unicorn Maritime (India) Pvt Ltd (“Unicorn”) as the discharge port agent. The cargo was discharged at Krishnapatnam port without the production of bills of lading by 31 August 2018 against a discharge letter of indemnity. The cargo was however not released to the receiver, Kamachi, because of its ongoing demurrage dispute with JSW. 

Shortly afterwards, on 10 September 2018, HSBC made payment under the LC, and Valency obtained an import trust receipt loan to repay HSBC. Valency also pledged to HSBC, by way of security, the 22 BLs for the cargo; and sent to HSBC a trust receipt for the release of the 22 BLs on the conditions (as are usual for trust receipts) that Valency would:

• receive the 22 BLs and take delivery of the cargo “exclusively for the purpose of selling [it] unless [HSBC] shall direct otherwise”; and
• hold the 22 BLs, the cargo and the proceeds of their sale on trust for HSBC and solely to HSBC’s order.

Valency collected the 22 BLs from HSBC under the trust receipt in two batches – on 13 September 2019 and 24 September 2019. Meanwhile, Kamachi was chasing Owners for the release of delivery orders for the cargo, which JSW was resisting on account of Kamachi’s failure to settle demurrage with JSW. Owners eventually took the position that demurrage was a matter for Valency to settle with Kamachi, and instructed Unicorn on 13 September 2018 to issue delivery orders for the Vessel. JSW also followed suit on 17 September 2018, and instructed Unicorn to release the delivery order for the cargo. Unicorn accordingly issued delivery orders and Kamachi obtained delivery between 17 September 2018 and 15 November 2018. 

Meanwhile, Valency’s import trust receipt loan with HSBC fell due on 24 September 2018. In order to settle this loan, Valency obtained two further loans from HSBC on 24 and 25 September 2018 by discounting (with recourse to itself) the 22 BLs with the bank. Kamachi however failed to pay for the cargo, making only one payment for 2,500 MT (of the 55,000 MT) of the cargo. 

Unicorn released all the cargo to Kamachi, but misrepresented to Valency that the balance of the unreleased cargo was 52,500 MT. It repeated this misrepresentation at least three times. Valency brought multiple claims against Owners, JSW, and Unicorn, including a claim for conversion of the cargo against the Owners and JSW on account of their release instructions for the cargo. 

Finding: A right to sue for conversion rests on possession or immediate right of possession

Valency’s claim in conversation against both the Owners and JSW failed. Central to the failure was the Court’s finding that Valency did not have actual possession, or the immediate right to possession, of the unpaid cargo at the time of the alleged conversion. 

On the facts, Valency argued that it had the immediate right to possession of the unpaid cargo on the basis that it had possession of the BLs. The Court, however, noted that the capacity in which Valency had possession of the BLs did not give it an immediate right to possession. At the time Owners and JSW issued release instructions, the 22 BLs were pledged to HSBC and released to Valency only under a trust receipt. The Court noted that where goods are pledged, the pledgee (in this case, HSBC) has the right to their possession. Until the underlying debt for the security is paid, the pledgee is the only person who may sue for conversion of the goods. The Court also noted the well-settled position that a trust receipt does not destroy a pledge, but maintains it despite the pledgee releasing BLs back to the pledgor. 

On the facts, Valency pledged the 22 BLs to HSBC as security for the import trust receipt loan on 10 September 2018, and obtained possession of the BLs on 11 September 2018 under a trust receipt which expressly preserved HSBC’s security interest. As noted, Valency repaid the import trust receipt loan on 24 and 25 September 2018. 

As such, from 11 September to at least 24 September, the BLs were pledged to HSBC, who was the party with the immediate right to possession to the cargo. 

For completeness, it is added that Owners and JSW also argued that since Valency was not named in the Import General Manifest (“IGM”), it could not have obtained delivery of the cargo from the Krishnapatnam Port authority. The IGM is a legal document containing information about the goods imported and the consignee or importer (if different), which the carrier or the discharge port agent was required to file. 

The expert witnesses for Valency and Owners agreed that under the IGM that was filed, only Kamachi was entitled to take delivery of the Cargo from the port and that certain steps had to be taken (including amending the IGM) or if necessary, a court order, before Valency could take delivery of the unpaid cargo from the port. The Court rejected this argument and clarified that the immediate right to possession, for the purposes of making a claim for conversion, refers to the right to legal possession. The fact that Valency had to take certain steps (including, if necessary, obtaining a court order) affected Valency’s ability to take actual possession of the Unpaid Cargo but did not affect Valency’s right to legal possession.

Comment: Pledged BLs under trust receipt  

It is often said that the BL holder has the right to sue for the goods in a claim for conversion: but this has to be qualified where the BLs have been pledged to a lender with the actual BLs released under a trust receipt mechanism. Applying trite principles, the Court clarified that the pledgor in such a case merely holds the BLs on trust for the bank. Since the trust receipt does not destroy the pledge, the right to possession of the goods remains with the pledgee bank, and a pledgor cannot therefore sue for conversion of the goods in its own right while the pledge remains on foot.  

The post BLs, pledges and the trust receipt: Possession as the touchstone for conversion claims appeared first on Trade Finance Global.

Facts

QBE Insurance (Singapore) Pte Ltd (“QBE”) issued a multi-buyer TCI policy to Novita Trading Limited (“Novita”) (the “Policy”) pursuant to which it agreed to indemnify Novita in respect of non-payment arising out of its “sale” and “Shipment” of goods on deferred payment terms with named buyers. Marketlend Pty Ltd (“Marketlend”) financed Novita for these trades by way of credit facilities. These facilities were supported by a trust whose trustee, Australian Executor Trustees Limited (“AETL”), was a joint insured under the Policy. Marketlend and AETL commenced proceedings against QBE in relation to eight claims that AETL submitted under the Policy concerning purported trades conducted by Novita.

Held

Insured Debt not proven on a balance of probabilities

The Claimants were required to prove the existence of an Insured Debt on a balance of probabilities, which in the Court’s view required showing an actual physical sale and shipment of goods by Novita to its insured buyers; and was to be distinguished from a ‘paper’ trade or a fictitious trade. On the evidence, the Claimants were unable prove the existence of an Insured Debt in respect of the claims.

The Claimants relied on Lloyd’s vessel reports and IMB reports as evidence of Novita having conducted genuine trades. The Court however found that these reports only showed that physical goods were duly shipped on board various vessels and transported to various destination ports.

They did not however “even begin to show” that “Novita was itself involved in shipping those goods at the port of loading or otherwise involved as an intermediate buyer/seller in the purchase in or onward sale of the goods”. Further, the Court noted that the mere fact that Novita came into possession of copies of bills of lading was neither here nor there for showing that Novita’s alleged trades were genuine, particularly given the lack of evidence from Novita explaining its possession of the copy bills of lading. The court earlier noted that intermediate traders may obtain constructive possession of goods by the receipt of the original bills of lading rather than actual possession of goods.

The acknowledgements of debt from Novita’s alleged buyers to Marketlend were also inconclusive as to the genuineness of their trades with Novita, particularly since it was always possible that the individuals providing the acknowledgements were not honest people; and the fact that they did not give evidence meant that their credibility could not be assessed.

The Court also took note of a number of features of the sale contracts between Novita and its insured buyers which were inconsistent, based on expert evidence, with market practice for the relevant commodities. These included the absence of any shipment period or delivery date, the incorporation of inappropriate standard form contracts, the requirement of presentation of packing lists for bulk cargoes (which do not require packing lists) and the lack of detailed specifications of the agricultural commodities being transacted. Novita’s refusal to cooperate with the Claimants to support the Policy claims was further found to support QBE’s case that the alleged trades were not genuine, and the Court was prepared to draw an adverse inference from Novita’s refusal to give evidence or otherwise assist the Claimants at the trial that the trades were not genuine.

Finally, QBE had, through its own investigations, reconstructed the entire sales chain for goods under two of Novita’s alleged trades. The confirmations provided by the shipper to the receiver of the cargo and all intermediate parties showed that the underlying goods were traded to the exclusion of Novita or its alleged buyers.

On the totality of the evidence before it, the Court found that the Claimants had not proven the existence of genuine trades on a balance of probabilities. Indeed, the Court went further to state the “irresistible inference” on a balance of probabilities is that all of Novita’s trades were fictitious.

Failure to provide evidence of transmission of bills of lading and shipping documents for a trade as a condition precedent to liability

The insured’s observance of all the terms and conditions of the Policy was a condition precedent to any liability under the Policy; and these terms and conditions included (i) providing documents and information requested by QBE relating to (among other things) any transaction between the insured and its buyer, and (ii) the obligation to cooperate fully with the insurer in relation to investigation and handling of claims.

As part of investigating the Policy claims, QBE had requested for copies of correspondence concerning the transmission of invoices, bills of lading and shipping documents from Novita to its buyers. None of this information was however provided.

The court was of the view that it is “plain” that such cover correspondence would fall within the insured’s duty to provide documents and information to QBE and/or to cooperate with QBE in investigating and handling claims. This is consistent the Court’s view that on a plain reading, an ‘Insured Debt’ under the Policy, required an actual physical sale and shipment of goods by Novita to its insured buyers. A shipment of goods by a party to another ordinarily involves the transmission bills of lading and shipping documents, making it “plain” that the insured was required to provide these documents. The insureds’ failure to provide these documents therefore constituted a breach of conditions precedents under the Policy.

Material non-disclosure and misrepresentations

Finally, the Court found that the fact of any one or more of the Novita’s alleged trades was fictitious (a) was plainly material to the risk which a prudent underwriter would be willing to undertake; (b) that if that fact had been disclosed, QBE would never have accepted the risk. Not only was Novita’s failure to make such disclosure was a breach of a condition precedent to the right to claim under the Policy, but also, it entitled QBE to avoid the Policy on grounds of material non- disclosure. The fictitiousness of Novita’s alleged trades also meant that Novita’s pre-Policy representations to QBE which indicated that Novita was seeking cover for losses incurred in its physical trading of commodities were false. These further entitled QBE to avoid the Policy.

Assignment of policy without insurer’s consent entitles insurer to avoid liability

As part of its invoice financing, Novita had “assign[ed] and agreed to assign absolutely to Marketlend all of its” rights under any insurance policy in which it may from time to time have an interest. Novita however did not seek QBE’s prior written consent for this assignment as required under the terms of the Policy. Failure to obtain such consent expressly entitled QBE to avoid liability under the Policy. The Claimants conceded that if consent had not been provided, QBE would be entitled to avoid liability as against both Marketlend and AETL. The court’s finding that there was no evidence of QBE’s written consent to an assignment of the Policy to Marketlend was in the circumstances fatal to both Marketlend and AETL’s claims.

—

This is a landmark decision for both the trade credit insurance business as well as the billion-dollar invoice financing market that heavily relies on trade credit insurance. Ultimately the risk of fictitious or paper trades remains prevalent and financiers should not assume or regard trade credit insurance as responding to fictitious trades. The use of copy of bills of lading to imitate a trade flow is a worrying trend but there are often other tell-tale signs of a trade flow not being genuine, including contracts that do not reflect market terms/practices.

In putting forward claims, an insured needs to be cognizant of its burden of satisfying the policy terms which in this case required a demonstration not only a sale of goods but also involvement in the actual physical shipment. As noted by the SICC, an intermediate trader may have constructive possession of the goods in the shipment by holding the original bills of lading even if it does not have actual possession of the goods.

There is much unhappy litigation between insurers and invoice financiers across the world arising from the collapse of traders that accessed financing through invoice financing programs. Such programs remain vulnerable to buyer collusion and impersonation and may invariably affect coverage under trade credit insurance.

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Often described as the lifeblood of international commerce, a bank can only refuse payment under an LC if the documents are non-compliant or if the seller who seeks presentation, has presented documents fraudulently. This, in turn, raises what seems to be a more basic question but one that does not have a uniform answer at law: what constitutes fraud, particularly when refusing payment under an LC.  

Singapore’s apex court decided the issue last week affirming the judgment for the banks who had refused to pay out on fictitious trades originated by Hin Leong Trading, the commodity trading corporation, through a pre-structured circular trade between Hin Leong, the commodities firm Trafigura, and Winson Oil Trading Ltd., an energy trading company. This involved Winson making false representations in its LOIs, as to:

1. Cargo being shipped pursuant to valid bills of lading (BLs) onboard the Ocean Voyager and Ocean Taipan (as described in the LOIs) for the Winson-Hin Leong Sale; and
2. Winson having good title to that cargo and having passed that title to its buyer Hin Leong.

The facts

Winson sued the banks OCBC Ltd. and Standard Chartered Bank (Singapore) Ltd. for non-payment under LCs that the banks had issued to pay for gasoil that Winson had sold to Hin Leong Trading Ltd. under two sale contracts. The sales by Winson to Hin Leong were the final legs of circular trades, involving the following chain of sales using copy BLs between Hin Leong, Trafigura, and Winson 

The banks argued that the pre-structured circular trade involving Winson did not have cargo shipped for the transactions and that the copy of non-negotiable BLs which purportedly showed such shipments were forgeries. In particular, the original BLs were allegedly used by Hin Leong to sell the same cargo to a different party under a different contract. Winson had relied on those copy BLs in preparing the payment letters of indemnity (LOIs) which it presented to the banks for payment. 

Payment LOIs are documents unique to the oil trade which a seller presents in lieu of the original BLs to obtain payment. By way of a payment LOI, amongst other things, the seller typically represents that cargo was shipped pursuant to valid BLs; warrants that it has good title, the right to transfer title to the buyer, and that it is entitled to receive original BLs from its supplier and transfer them to the buyer (and thus, pass possession of that cargo on board the vessel). These were the representations said to be fraudulent. 

Fraud by any other name is still fraud 

The classic test of fraud is contained in Derry v Peak as constituting three limbs: when a false representation has been made (a) knowingly, (b) without belief in its truth, or (c) recklessly, careless whether it be true or false. The first instance court found that the representations made in the LOI were fraudulent in the sense of reckless indifference to the truth or falsity of the statements. The principal question of appeal was whether the fraud test also encompasses the third limb of reckless indifference, particularly in the context of LCs which create independent payment obligations. 

Derry v Peak was a case based on the tort of deceit. Likewise, the law on independent guarantees such as performance bonds has also established a fraud test which includes the third limb of reckless indifference. However, the argument before the Court of Appeal was that a narrower standard of fraud should apply in LC cases to avoid the danger of diluting the autonomous function of an LC which is the backbone of international trade. 

An earlier decision of CACIB v PPT (SGHC 2022) which held the third limb would not be sufficient to establish fraud in LC cases. The authors of this article disagreed with the decision of CACIB in 2022 in that there is no principled basis to have different fraud tests when dealing with letters of credit (compared with performance bonds), a position now clarified and supported by the decision of the Court of Appeal. 

The principle behind including a fraud test that covers recklessness is best captured by the observations of Chao Hick Tin JA in Beam Technology v Stan Chart (SGHC 2013): 

“While the underlying principle is that the negotiating/ confirming bank need not investigate the documents tendered, it is although a different proposition to say that the bank should ignore what is clearly a null and void document and proceed nevertheless to pay… [t]o say that a bank, in the face of a forged null and void document (even though the beneficiary is not privy to that forgery), must still pay on the credit, defies reason and good sense.”

The Court noted that it would be incongruent if the bank had to pay because it could not avail itself of the recklessness limb, even though after paying the beneficiary, the same bank can mount a claim in the tort of deceit to recover the same amount from the beneficiary. In that regard, the Court deemed the standard of fraud should not be so narrow to allow the beneficiary to bury its head “ostrich-like in the sand”.

What constitutes recklessness? 

The Court of Appeal also clarified that the third limb of recklessness does not create a duty of care between the bank and the beneficiary. In that regard, recklessness in Derry v Peak was a subjective test – an indifference the defendant is conscious of and not an objective test synonymous with negligence. Recklessness in the third limb is defined as:

“where the fraudster does not actually have sufficient certainty to know the true state of affairs but take steps or chooses not to take steps in order to isolate his or her mind from the truth.” 

Recklessness in this sense does not mean the risk inherent in the transactions but a risk that arises because of ‘red flags’ that should prompt the beneficiary to do the necessary checks before the beneficiary can be said to have formed an honest belief in the truth of the representations. In the present case, the red flags were not to be viewed in isolation but in a continuum to support the finding of reckless indifference as to the verity or falsity of statements made. 

The red flags – where are the original BLs?

The uniqueness of the case was that Winson had made an earlier presentation to OCBC for the Ocean Voyager but when the presentation was rejected on the basis that there “was no physical cargo that was shipped to the Ocean Voyager”, Winson made a second presentation to OCBC by switching the vessels and preparing new invoices to Ocean Taipan. 

Instead of checking with Hin Leong on the loading documentation or the original BLs, Winson simply switched the documents for Ocean Voyager and presented them to SCB instead. This was one of several red flags, leading up to the relevant point of assessment – Winson’s representations at the time of the second presentation to OCBC.

In particular, Winson’s conduct regarding the absence of queries of the original BLs even when faced with the rejection of the first presentation by OCBC, as well as the absence of the loading documentation featured heavily in the decision both at first instance and Court of Appeal. Other red flags raised included: 

Pre-structured circular trades using copy BLs: The issue of whether the trades were pre-structured was relevant to Winson’s state of mind, i.e., whether it had an honest belief in the representations it was making as to the cargo and its ownership. Of note, Winson’s LOI (based on Hin Leong’s copy BL) representing goods shipped on board Ocean Voyager simply had no basis when it was issued before Winson’s supplier had issued its LOI. In other words, via its LOI, Winson was holding out its cargo was loaded on the Ocean Voyager, at a time when the vessel could have been substituted by its supplier who had yet to issue its LOI to Winson confirming that the cargo was indeed loaded. 

No Original BLs: While the court noted that circular trades may not be unusual per se in the oil trading market, what was unusual was the use of LOIs in a situation where all relevant parties were based in Singapore, which should have facilitated the ease in producing original BLs and the loading documents. The Court noted that a party like Winson would have been expected to query why the original BL were not available, even more so when a copy of the BL became somehow available but not the original. 

Lack of loading documents and inability to produce Original BLs: The court noted that “the critical original BL and loading documents remained inexplicably unavailable” even some 13-16 days after the vessels were loaded with the Ocean Taipan loaded at Universal Terminal Singapore (a terminal controlled by Hin Leong) and for which the loading documents should have been easily accessible. Even after OCBC had rejected the first presentation, it appeared that Winson did not even approach Hin Leong or Ocean Tankers for the original BLs, when it was communicating with them at the material time. 

Change in quantity after issuance of Ocean Taipan BL: Winson failed to ask for an explanation for a change in the quantity of gasoil, even when that change remarkably came about after the BL fixing the quantity was issued. 

Winson’s concerns over clean title of the cargo: Evidence pointed to Winson’s concerns over whether there was clean title of the cargo when discussing with OCBC for a prospective sale to a third party when news of Hin Leong’s financial difficulties came out.  

A new standard for sellers presenting under an LC? 

The facts of the case are so unique that they are unlikely to replicate; nonetheless, key themes emerge for traders and lenders to understand. Creative structures like repos, circular, and sleeving arrangements in oil trading, put a trader further away from the actual physical cargo being traded and the critical original BL, increasing the risk of fictitious trades. 

Concerns persist about questionable practices in oil trading. A troubling trend is that market participants appear happy to insert themselves into chains fraught with red flags, using LOIs instead of BLs. This practice is often justified by the perceived safety net of an independent payment guarantee of a bank as backing.

But the case is a timely reminder that the buck doesn’t always stop with the bank. Traders being asked to insert themselves into a chain and present documents for an easy small margin would no longer be rewarded for burying their heads in the sand when confronted with dubious signs. 

A payment LOI should no longer be seen as a single piece of paper to trigger payment under an LC, but one that contains heavy representations as to the essential feature of the trade – that cargo was shipped pursuant to valid BLs and that the seller has and will pass good title to that particular cargo.  

The risk/reward paradigm has shifted, and recklessly indifferent traders might find themselves facing a huge unpaid exposure for what is effectively a margin of a few dollars per ton.

The post The law should call a fraud, a fraud: Singapore settles the fraud test in Letters of Credit appeared first on Trade Finance Global.

The overreaching arc of sanctions regulations is threatening the certainty of payments guaranteed by the smooth functioning of letters of credit (LC) in international trade.

This tension recently played out in the Singapore courts in a judgment handed down recently (Kuvera Resources Pte Ltd v JPMorgan Chase Bank, N.A. [2023] SGCA 28). 

The Singapore Court of Appeal overturned the first decision in Singapore concerning the enforcement of a sanctions clause. In November 2022, the High Court found that a sanctions clause had been validly incorporated into an LC confirmation, and it allowed the Singapore branch of JPMorgan Chase Bank, N.A. (the “Bank”) to decline payment to the beneficiary. 

The Court of Appeal upheld the findings on the incorporation of the sanctions clause, but considered that the clause did not justify the Bank’s failure to pay under the LC.

The Court found that the Bank’s risk-based decision, preferring to be sued by the beneficiary than be found by OFAC to have breached sanctions, was not contractually justified. 

Facts on Kuvera Resources v JPMorgan Chase Bank

The Bank had confirmed an LC issued in favour of Kuvera Resources Pte Ltd (“Kuvera”). All of the Bank’s advice and the confirmation contained a sanctions clause which (among other things) effectively precluded the Bank from paying if documents presented under the LC involved a vessel subject to US sanctions. 

Kuvera made a presentation under the confirmed LC concerning a cargo that was carried onboard the Omnia. During an internal sanctions screening, the vessel showed up in the Bank’s internal ‘Master List’ of entities and vessels determined to have a sanctions nexus. 

Whilst the Bank was unable to identify the beneficial owners of the Omnia, it relied on certain red flags concerning the vessel’s ownership. In particular, the vessel was previously called the Lady Mona, and its beneficial owners and technical operators had Syrian links. 

After her name changed and she received a new registered owner, it became impossible to ascertain the beneficial owners of the vessel or her technical and ISM managers. OFAC also issued guidelines and advisories placing US persons on notice of deceptive shipping practices undertaken to evade US sanctions. 

These practices included changing the names and registered owners of vessels, and using layered ownership structures to mask the fact that the ultimate or beneficial ownership of the vessels rested with sanctioned entities. 

OFAC specifically identified changing vessel names as a common evasive practice in relation to vessels owned by Syrian entities.

The Bank led uncontradicted expert evidence (Kuvera not having led any expert evidence) that OFAC would have found a breach of US-Syrian sanctions if the Bank made payment under the LC in respect of a cargo carried on the Omnia in the circumstances. 

Are red flags enough? 

In the first instance, the High Court found that OFAC would have found that payment under the confirmed LC would amount to a breach of sanctions.

It reached this conclusion on the basis of the Bank’s expert evidence, which highlighted (among other things) that the red flags in OFAC’s guidelines concerning masking ownership of vessels also applied to the Omnia. 

For the same reasons, the High Court was also independently satisfied that paying Kuvera would have amounted to a breach of sanctions. 

On appeal, the Court of Appeal held that the enquiry of whether a vessel is subject to any applicable restriction should be determined on an objective basis without any (potentially speculative and arbitrary) extrapolation of third-party input from entities such as OFAC. 

The court highlighted that while the court had to approach the question of the vessel’s ownership on a balance of probabilities (requiring a more than 50% chance of a Syrian connection), OFAC was not constrained by similar rules of evidence. 

The detection of red flags highlighted in OFAC’s advisories with respect to the ownership of the Omnia was found to be inconclusive circumstantial evidence, which created at best, an unresolved possibility that the Omnia may be caught under America’s Syrian sanctions.

The court also found it relevant that the Bank had taken a decision on its own risk assessment, preferring to be sued by Kuvera than being found by OFAC to have breached sanctions, without having objectively assessed the likelihood of the vessel having Syrian connections. 

Such a decision could not be justified simply because a sanctions clause had been inserted into the confirmed LC. The Bank still had to prove a breach of the sanctions referred to in the sanctions clause.

The vessel’s new registered owner was a Barbados entity, and her technical and ISM manager was a UAE entity. 

The key question before the Court was whether the bank had shown that the Omnia, under her new registered ownership, remained under Syrian beneficial ownership. 

Regarding this, the Court found that the Bank had not displaced the prima facie inference of ownership arising from a registered non-Syrian owner. 

It was not sufficient to suggest that just because information on her beneficial owner or the beneficial owners of her technical and ISM manager was not available, it must follow that there is some masking or concealment of beneficial ownership. 

The suggestion that a registered owner may be a shell company was inconclusive.

Legal analysis: The need for objective assessments

Certainty of payment continues to be a guiding touchstone and a bank seeking to withhold payment on account of sanctions would have to objectively show how the payment constitutes a breach of the applicable sanctions. 

It is clear that a subjective assessment by a bank through its own risk assessment is not sufficient (e.g., a decision justified by a preference to be sued by the beneficiary rather than being penalised by OFAC).

Critically relying on OFAC’s guidance might not in itself be sufficient to establish that objective requirement to justify non-payment. 

A sanctions clause construed by reference to an objective and identifiable set of laws which apply to the bank would be more certain, but would still erode some of the commercial certainty that LCs offer. 

This is because a breach of sanctions is not always clear-cut. Barring the unlikely instance of a decision from the courts of the relevant jurisdiction on the sanctions in question and on similar facts, questions of interpretation of the sanctions and their application to the facts are bound to arise.

Whether foreign sanctions are in fact breached can be a thorny question of applying the relevant sanctions laws to the facts. 

The post Kuvera Resources v J.P. Morgan Chase: Certainty of payment vs risks of breaching sanctions under Letters of Credit appeared first on Trade Finance Global.

The fallibility of paper documents is often blamed as the source of the problem, but sometimes the real danger lies in the intangible aspects of human psychology behind decision-making processes. A compelling narrative and competitive lending market set against challenges in the verification of trades and finances can unwittingly lead a lender into a blinkered decision. 

Far from sophisticated, trade fraud can be so breathtakingly simple that the mind does not address and arrest its possibility (see: Annex 1 modus employing photocopy BLs). The deception often occurs well before the fictitious trade peddled and lies in the all-consuming need for liquidity. Having worked on trade fraud cases for close to a decade, the common denominator in most, if not all, cases is that liquidity is the actual commodity being traded. 

Cobbling a trade together can mean accessing the lower costs of borrowing in Dubai and Singapore and applying it elsewhere: for other trades, for working capital or even to unrelated investments in other sectors/geographies with high borrowing costs. Liquidity could also be transferred by loans between traders, dressed up as transactions where the physical goods are secondary or sometimes completely absent. 

As it is, structured trades where trades are sometimes conducted forwards, backwards and then in circles, are deployed to seek financial arbitrage (see: Annex 2 where a circular trade between related companies creates multiple financing and might even be seen as a loan). The temptation to create such structures, even without the underlying goods, cannot be understated. Balance sheets soar, everyone benefits and, in any case, who will find out?

The balance sheet bias 

The need for liquidity highlights the central role of having a positive balance sheet. Balance sheets provide a visible insight into the financials of the company, but also provide a far more powerful force that can make a compelling case: narratives. 

The hype around an individual or company level creates a powerful self-perpetuating loop, where lenders might take the balance sheet as gospel and gloss over doubts. But balance sheets have historically proven to be poor tools to accept unquestioningly. The balance sheet is, at best, a snapshot of the company’s financial health at a point in time. 

There are weaknesses in the document because it doesn’t give a clear indication of leverage. There is no distinction between structured trade and physical trade (the former arbitraging on financial positions rather than physical goods). Receivables, sometimes the only asset of a trader and the backbone of receivables financing, can often be difficult to verify or distinguish from a secondary loan from your borrower to its “buyer” (see: Annex 2). In a world where the balance sheet is supreme, there is every temptation, opportunity and ability to dress it up to fit the narrative instead of reality. 

A healthy dose of scepticism towards the balance sheet would facilitate a critical analysis of the growth story of the company. 

How did the company go from a $10 million turnover to $100 million in just a few years; how does a company borrow at 10% interest from private lenders to trade a product that makes a 1% margin? 

The biggest blind spot tends to be when the lender is actually part of that growth story – this is how modest lines can turn into staggering sums without ever visiting the offices of their borrowers to test the financials against reality. 

Can a handful of people run a $100 million balance sheet; can one trader be responsible for 10 different products; is the owner the sole decision maker? Lenders might deploy such checks at the onboarding stage_, but reliance on “track record” might catch them off-guard when traders move from physical trades to purely financial structures over time. 

Groupthink: Others can’t be wrong

Even when circumspection in the balance sheet starts to creep in, biases tend to find a justification. Trade finance is a high-velocity and competitive business where decisions need to be made fast. The involvement of other lenders is perhaps one of the most persuasive factors that can sway a decision, even if it is never articulated. 

It once again provides confirmation bias as it diverts attention from ambiguities in the statement and encourages a logical fallacy that the involvement of other lenders is some form of quality assurance. This can also amplify the desire for involvement in what can loosely be described as a fear of missing out. 

Interrogating the trade 

The lure of an impressive balance sheet might divert attention from the fundamentals, i.e., the trade. Fraud flourishes in fragmented information chains: physical goods are placed in the custody of a third party, such as a vessel carrier or warehouse operator, while the trades are being conducted on paper with the passing of title documents by traders using financing. 

It is this disjunct which lies at the heart of most trade fraud. Shipping documents can only tell you information relating to the start and finish points of the journey but it is the mid-point of the trade where fraud can occur. When we investigate trade fraud, we painstakingly piece together the actual movement of physical goods from shipper to receiver. That knowledge shouldn’t just be the purview of litigation lawyers like myself, but would be better placed before credit and risk committees prior to a lending decision. 

More importantly, interrogating the trade is really ensuring that each party in the trade can justify its role in the chain: why is a small trader inserted as a sleeve in between two large traders; why are trades being conducted in circles; what has the trader done to verify title back to the shipper listed in the BL? 

In two recent cases in Singapore involving letters of credit payments by Credit Agricole and Unicredit for trades involving Zenrock and Hin Leong, financing a segmented trade flow without clear visibility of the full trade flow left the banks exposed. Credit Agricole was left paying out on a fictitious double-financed trade by Zenrock, while Unicredit’s weakness appeared to be its unawareness that its borrower, Hin Leong, resold the goods back to the seller in a flash title repo transfer (see: Annex 3).

Interrogating the trade needs to be a dynamic process rather than a static assessment, as savvy traders are able to have their trades under the radar, for example, by reducing the shipment size or cargo value to the right price to avoid enhanced due diligence. 

Testing your security 

The hallmark of trade finance is its self-liquidating nature. Holding title documents such as BLs should give the lender a right to possession of the goods, and the failure to deliver the goods can lead to a legal case. 

In recent misdelivery cases in Singapore, banks have found it less than straightforward to enforce their security of BLs through misdelivery claims against shipowners. Both SCB and OCBC were unable to convince a Court to get a summary judgement, as the Court believed questions on the banks’ treatment of the BL and security should be examined at trial. 

The cases demonstrate the danger of treating the requirement of a BL as a checklist item, particularly when the bank may be aware that the cargo represented by the BL has been mixed into a new cargo or even discharged at the time of issuing the facility. The BL isn’t just a document to be kept in a folder – as a security, it needs to be constantly tested in case enforcement is needed. 

Poor investment choices aren’t limited to trade finance. But trade finance often presents an intoxicating mixture of invincible individuals, glamourised financials and compelling narratives that play on our bias and divert our attention from the substance of the trade and the credibility of the narratives being peddled. The solution is not in stopping trade finance but by creating enough checks and balances that address the fallibility of the human psyche as much as the robustness of the trades. 

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