AlGosaibi v Maan AlSanea - Fortis Bank versus ADIB - The Letter of Credit

See important additional information here on Bunge's role in transaction and ADIB's knowledge of the nature of the transaction.

As promised a look at the Letter of Credit ("L/C") issued by Awal Bank which Abu Dhabi Islamic Bank ("ADIB") advised and confirmed to Fortis Bank Netherlands.

The text of the L/C issued by ADIB through Fortis is Exhibit #2 to Document #24, the Declaration of Nuhaid Saliba dated 31 August 2009. Note Exhibit #1 is the text that Awal proposed to ADIB.  That of course is not the instrument on which Fortis relied and through which ADIB conveyed its irrevocable undertaking.  Exhibit #2 is the key document as ADIB is its author.

And just to be complete, as you'll recall, ADIB is asserting fraud as the basis for voiding its obligation but not fraudulent documents or fraudulent shipment or non shipment.  Most jurisdictions have held that if the documents comply with the terms of the L/C then the bank is obligated to pay.  The "fraud" defense is applicable only in very limited circumstances.  

These and other documents can be found at the NY Supreme Court Website http://iapps.courts.state.ny.us/webcivil/FCASMain  under Case # 601948/2009, 

Let's step through the details of the L/C.

1. Issue Date: 16 June 2008.
2. Expiry Date:  14 July 2008
3. Applicable Rules:  UCPURR = Uniform Customs and Practice for Documentary Credits (#600 of 2007) and Uniform Rules for Bank-to-Bank Reimbursement under Documentary Credits (#725 of 2007).  The former sets forth the rules for the handling of L/Cs.  The latter the rules for banks to reimburse or pay one another   These are pretty much the standard governing principles for commercial letters of credit (aka "documentary credits").
4. Issuing Bank:  Awal Bank BSC Bahrain
5. Applicant - AlGosaibi Trading Services Hamilton Bermuda
6. Beneficiary - Bunge SA Switzerland
7. Currency/Amount:  US$39.999,996.52
8. Payment:  360 Days after acceptance of documents.
9. Port Loading:  Any port in Brazil.
10. Final Destination: Any port in Taiwan and/or Spain.
11. Latest Date of Shipment:  30 June 2008.
12. Goods Description:  (a) 52,686.31 MTS of Brazilian soybeans, packing in bulk at US$564.90 Per MT CFR Taiwan (b) 30,000.00 MTS of Brazilian maize SLM packing in bulk at US$341.25 per MT CFR Spain.  (Note: CFR = Cost and Freight)
13. Documents Required:  (a) One copy of commercial invoice.  (b) One photocopy of the bill of lading. (c) One copy of beneficiary's certificate stating that the copies of shipping documents provided are true and correct copies of the originals.  That the original bills of lading relating to the shipment should be sent to the Notify Party stated in the B/Ls or to the agent at destination and that the goods described should be discharged at the port state in the B/Ls.

Additional Conditions:

1. Third party documents except drafts and invoices acceptable.
2. Documents showing one or more third party (ies) as shipper and/or exporter are acceptable.
3. Fax or photocopy of documents are acceptable.  Documents issued before LC issuance (including B/L) are acceptable.
4. Documents acceptable inspite of any and all discrepancies with exception that invoice value drawn may not exceed the maximum letter of credit value and the letter of credit may not be expired.
5. Typing mistakes do not constitute a discrepancies.
6. Late presentation of documents is accepted on the condition that documents are presented within LC validity.
7. Bill of lading presenting a greater quantity/amount than shown on invoice is acceptable.
8. Documents shall be acceptable as presented.
9. Abu Dhabi Islamic Bank Abu Dhabi UAE is authorise to confirm this L/C and advise it to Fortis Bank Rotterdam.
10. Fortis Bank Rotterdam is authorised to confirm this L/C at the request and for the account of the beneficiary.  The confirmation of the first advising bank, that is Abu Dhabi Islamic Bank, Abu Dhabi UAE covers the obligation of the issuing bank, that is Awal Bank BSC, Manama and the confirmation of the Fortis Bank (Nederland) NV Rotterdam only covers the obligations of the first advising bank, Abu Dhabi Islamic Bank, Abu Dhabi UAE.
11. Charges:  ADIB's confirmation charge (a cool US$500,000) for Awal.  Fortis' charge (not specified here) for Bunge.

Now to the tafsir.

First, as is pretty clear from the text of the L/C this is not a typical documentary letter of credit.  It is closer to a standby letter of credit - which you can think of as a guarantee of payment.

1. At no time do any of the banks involved have an original bill of lading in their possession.  An original bill of lading is generally required by a shipping company to release goods it has shipped.    Having the B/L provides a measure of collateral security, if the applicant does not pay.  Now in a transaction in which the bank is giving its obligation to pay the beneficiary in the future (in this case 360 days after it accepts the documents) having the B/L only provides collateral comfort for a short period while it is at risk for the applicant or issuing bank's failure to pay.
2. In Additional Conditions #4, the issuing bank has explicitly waived all and any discrepancies in the documents except for the amount drawn under the credit and presentation within the L/C validity.  That means any other condition.  Hardly the stance that a party concerned with the underlying commercial transaction would take.  The power to refuse payment for discrepancies (in the documents) provides a way to enforce the terms of the contract on the seller. Giving this right up doesn't make a lot of commercial sense.
3. In Additional Conditions #7, B/Ls showing a larger quantity are acceptable.  Under UCP 600, for bulk commodities, a variation of +/- 5% is allowed (Article 30 (b)) unless prohibited.  5% of the amount shipped would be roughly US$2 million.  Would all of you out there who think that Bunge is going to ship another US$2 million worth of crops but not get paid for them, please raise your hands?  Didn't think I'd see any.  Of course there is no harm in this clause as it benefits the applicant.   But what is the commercial reason this would be included?  
4. A couple other conditions are worthy of mention.  As noted above, Additional Condition #1  allows third parties on the shipping documents.  Meaning the shipper need not be Bunge and the party receiving the goods need not be AlGosaibi.   Additional Condition #3 allows documents to be dated prior to the L/C issuance. Faxes of documents are acceptable.  Coupled with the earlier waiver of  all discrepancies except for payment amount and presentation within L/C validity, all this looks like setting up the conditions for document shopping.  That is, making it very very easy to find conforming documents from another trade transaction not involving the parties named in the L/C.  All one needs is access to documents and a photocopier.

Second, is there a commercial reason for such a structure?  Possibly but how likely?

1. The above conditions would be useful if both parties were engaged in rapid turnover trading.  Bunge strikes a deal with ATS at price X but finds another seller willing to sell at less than X.  Being able to substitute sellers/shippers allows Bunge to make an additional profit by buying the goods from this other party and delivering to ATS.  This condition allows ATS to sell the goods  to a third party, Buyer B, before it has taken possession by switching the delivery party.
2. But waiving the right to refuse to pay for any discrepancies could be problematical if ATS has on sold the goods as described to new Buyer B.   One would think Buyer B would have stipulated certain quantity and type of goods and reserve the right to refuse payments if these and other conditions that it required were not met.  Now perhaps Buyer B has waived these.  But what are the chances?  The goods are the commercial heart of the transaction.
3. On that score it might be more typical to see an inspection certificate (of the goods) particularly since a third party shipper might not be as reliable as Bunge. 
4. Now it's not unheard of that cargoes already at sea are sold (remember that documents issued prior to the L/C issuance date are acceptable).  But at that point, one should know the exact quantity of the goods and the identity of the parties.  And this could be incorporated into the L/C.  Now, I suppose the transaction could be taking place so quickly that speed was of the essence - a split second response required.  However, the documents submitted in the case indicate that ADIB cogitated for a while (though perhaps not long enough) before agreeing to the transaction.  And then it appears the transaction amount was increased after it had given an approval for a lower amount.  And so it had an opportunity like Proud Edward "tae think again".  Though to be fair, ADIB seems like Proud Edward to have thought again after "24 June" and not before.
5. Generally, transactions of this sort would be secured (from the intermediary buyer's perspective -- here ATS) by use of a transferable letter of credit (opened by the final buyer Buyer B in favor of ATS).  Or through a "back to back" L/C which is a particular favorite among many MENA banks though it is technically less sound from a protection perspective, including for the issuing/confirming banks of the second or "back to back" L/C.

Third, so what could be another reason for this structure?   To provide Awal and/or ATS financing.  But this requires a few bits more in the structure.

1. This L/C provides for a payment to Bunge 360 days from documentary acceptance.  At this point there has been no movement of funds.  Now it's not uncommon in such situations for the seller (Bunge in this case) to ask the confirming bank (Fortis) to make an immediate payment.  The bank would "buy" (discount) the acceptance for an amount less than its face value.  You can think of the difference as interest.  This could get the money to Bunge, though strictly speaking that's not necessary to get funding to ATS/Awal.  
2. If you reflect on the typical "Islamic" "trade" financing described above, you'll see that the ADIB L/C is the equivalent of the purchase of the goods on deferred payment basis.
3. Getting the funds to Awal/ATS requires the other half of the "Islamic" "trade" financing structure: the offsetting transaction the sale of the goods for spot settlement.  Such as sale could be either back to Bunge.  Or to a third party.  This may be a reason why ADIB's lawyers are pushing for further disclosure by Fortis to see if they are involved in this critical leg.
4. Just to close the Bunge circle.  The usual "Islamic" "trade" finance transaction keeps the deal "all in the family" so it's not inconceivable that they might have been involved.  If Bunge were involved, one would presume that it discounted the Fortis payment to use as the purchase price back from ATS/Awal - of course with a suitable commission for its trouble.   Note:  This is hypothetical.  I have no knowledge of Bunge being involved in the second leg. This discussion provides an illustration of how the transaction may have been structured.  Not that it was so structured.
5. Presumably, ATS did not hang on to the commodities with the intent of selling a year later.  Equally, it's unlikely that ATS has a "factory" in which to process the goods.  So the likely disposition of the goods is a sale.  If the goods were sold on a spot basis, then ATS/Awal have a one year loan due when the Fortis acceptance "matures" - irrespective whether Fortis has or has not discounted that obligation.
6. It's well known out there that commodity companies and brokers (including the one named in the TIBC  BNPP / ADIB legal dispute) specialize in providing "trade documents" for "Islamic" "trade" transactions that are really disguised financings.  Because Shari'ah Boards have become a bit more alert, many of these parties have established special purpose subsidiaries with completely different names so the buyers and sellers appear to be unrelated parties.   And have made presentations to  banks who wish to engage in "Islamic" "trade" transactions (or loans if you'd prefer) on how they  can help.
7. How does this work?  The financing bank arranges to acquire goods from Company A (Let's call it Dewey Night Company).  It then sells them to the Buyer (borrower if you will) on a deferred payment basis (the tenor of the loan) at original cost plus a mark-up.  At the same time it offers to sell the goods spot for the Buyer (borrower) to another company (Let's call that one "Eagle" Trading Company).  Usually the Murabaha contract (for this is a Murabaha trade transaction not a loan!) specifies that the spot sale cannot be for less than the original cost. The helpful commodity firm or broker provides all the required documents for the two sales   The mark-up miraculously just happens to equate to the interest on the loan.  Proving that in some forms of "Islam" miracles are indeed common. The commodity company makes a fee for its role - just as the innkeeper makes a profit for renting you a room for a night.  Documents are available for the Shari'ah Board to review if it wants.  These on their face document a trade transaction.  It seems everyone is happy.  و الله اعلم
8. And if you'd like to place a deposit with a bank, you can do the reverse transaction.

Fourth, how does this transaction differ from a typical "Islamic" "trade" transaction?

1. The ultimate financing bank in the transaction is ADIB.  While it is true that it does not advance funds, it is ultimately on the hook if Awal does not pay.  Under its confirmation it is obligated to pay Fortis if Fortis claims within the validity of the L/C and complies with the miniscule conditions provided.
2. For this transaction it only requires half of the set of documents.  A bit less financial engineering.
3. More importantly what is in effect a guarantee or a standby L/C is treated as a commercial L/C with a lower capital charge under Basel II.  Thus, ADIB's risk adjusted ROE/ROA is higher.  And more importantly, its CAR is higher.

Fifth, how credible is ADIB's sudden charge that something was wrong with the transaction?  That there was potential for fraud.

1. First, to accept ADIB's contention, one has to begin by assuming that ADIB has a very limited understanding of letters of credit and UCP600.  Or that the L/C Department personnel assigned to this transaction were incompetent.
2. Second, one also has to assume that ADIB is rather new to structured transactions.  However, since AA has seen ADIB's "Islamic" "trade" documentation of various flavors, at least for AA accepting that is more than a "bit of a stretch".
3. Third, the documents submitted by lawyers in this case indicate what would appear to be scrutiny of the transaction by ADIB's credit department.  If this transaction "slipped by" and wasn't recognized as a "structured" transaction - a payment guarantee and not a trade transaction - then one has to draw some rather unfortunate conclusions about credit analysis and risk management at that bank.
4. Rather what seems to have happened is that ADIB decided for about 500,000 good reasons (the US$ equivalent of the confirmation commission it received from Awal) to go forward with a structured transaction.   One that had some CAR advantages.  
5. Now that Awal has hit the wall, in what sadly seems to be a tradition of some "Islamic" banks (paging TID in re BLOM)  it's looking for a legal way out. (Paging Abu Yusuf).  At least in this case, it doesn't appear they're resorting to spurious arguments regarding the Shari'ah.
6. Finally most of what is labeled "Islamic" "trade" finance  is structured with manufactured transactions   All the parties (save perhaps for the Shari'ah Boards) know that these transactions are structured.   That they are really money on money loans, dressed up in thaubs and ghutras to disguise the reality.  For ADIB to suddenly claim ignorance of this is well beyond the plausible. 

A bit later I'll post some more comments on this case.  In the interim, you can look at the NY Supreme Court website.  Documents #78 and #79 contain letters by the two sides recapping the main points of their arguments.