Bills of Lading in Commodity Trade
O'Brien and Madan on the Current Setting and Future Direction
Vincent O’Brien, Associate Director of IIBLP and DCW Contributing Editor, discusses the role of the bill of lading in commodity trade and the escalating occurrence of usance LCs allowing for presentation of photocopy bills of lading with Ashish Madan, Director of Adam Smith Associates, an Indian firm specializing in trade finance. Their discussion took place during ICC Banking Commission Annual Meeting in Beijing in April 2019.
VOB: In international trade deals – Title, Risk, Possession, and Reward pertaining to goods being traded are separate concepts albeit strongly interrelated. However, there are a lot of misconceptions as to what “Title” really means when it comes to the Bill of Lading. Ashish, in simple terms how would you describe the primary purpose of a bill of lading as a document of title?
AM: Simply put, the main purpose of the BL is to enable the holder take possession of goods from the vessel. In this context, it has commonly come to be referred as the document of title and its quasi-negotiability has enhanced this function.
VOB: Ok, I agree that what you just said is correct but, to be frank, these words mislead parties to consider that “title’ to goods derived from surrender of an original bill of lading equates to “ownership” of the goods.
AM: You are absolutely correct. An important clarification should be made with regard to this function of the BL as a document of title. The BL is a document of title of possession of goods. In other words, it is basically a symbolic representation of custody of goods. This is different from title in goods itself. Specifically, title/ownership/property in goods passes from one party to the other, namely seller to buyer, when the trading parties actually intend it to pass. The intention is therefore the key and the clearer this is represented between the contracting parties, the better. Usually the seller will retain the title and link the transfer of title to a specified event which, in modern times, this event is typically evidence of or actual receipt of payment.
VOB: Ok, I am with you in theory but can you give us an example to understand the actual practice?
AM: Sure, as a simple illustration the consignee on the BL could be an agent of the seller or principal. In this situation the principal is the seller who merely authorizes the agent to take physical possession, or should I say, take hold of the goods which the agent would do through the BL simply being consigned to him. Obviously, the title or actual ownership of the goods does not change hands. To put it another way, the party which had title to possessing the goods, namely the agent, also referred to as bailee in many jurisdictions does not actually acquire property in them. While it is an oversimplification, the concept is a bit like a cloakroom ticket – you have the right to pick up the coat on surrender of the original cloakroom ticket but the released coat may not necessarily be your coat.
VOB: Ok, you have made it clear that right to “possess” or hold is quite different to “ownership” – nicely put! What about risk transfer versus actual ownership as you have clarified?
AM: Let’s be clear: Risk is different from ownership. To extend my illustration, risk could pass on to the buyer with delivery of the goods unless otherwise contracted. Basically, two situations are possible. First, risk passes on without property in them being passed to the buyer. Second, both risk and property can pass on to the buyer.
VOB: Would it be fair to state that if a seller has received payment for the goods then it can be taken that the risk and actual ownership has changed hands?
AM: The receipt of payment for the goods can be considered as the reward or the consideration received by the seller from the buyer for supply of the goods. The terms of trade, i.e. the price, consideration, and terms of payment are the prerogative of the trading parties. When the reward is received it is reasonable to presume that ownership has changed hands, unless of course otherwise stated in the contract.
VOB: So far, so good but can you add some clarity for our readers. For example, it can easily happen that some of these important points are missed or overlooked in a contract between seller and buyer?
AM: You are correct and it happens. For clarity on risk, title, and price - reference may be made as you suggest to the terms of the contract wherein the seller and buyer have reached agreement on these issues. If not expressly covered in the contract then greater reliance to statutes and laws may be made if the contract is silent on these issues. As long as there is consideration for sale of the goods and eventual passing of title, freedom to trade (and terms of trade thereof) cannot be curtailed. If I can delve a little deeper ...
VOB: By all means proceed. AM: The reasoning above is, for example, in my view consistent with the Sales of Goods Act 1979 of United Kingdom. The act differentiates between ascertained goods and unascertained goods. In case of ascertained goods, section 17 (1) provides that property passes on such terms as the parties intend it to pass. In case of unascertained goods (typically bulk cargos), section 20A provides that the property passes on to the buyer upon payment. In bulk cargo, s20A enables the merchant to buy part of the bulk and further resell to a sub-buyer. According to the Law Commission Report of the United Kingdom (no. 215), s20A enables co-owners to deal freely with their undivided share. In practical terms, within the context of this act unascertained goods get ascertained and thus title passes when the parties intend it to pass. So you can see the intention is very important. Furthermore, section 20B mandates that any owner in common falling with the provisions of s20A consents to any delivery to any other co-owner. Moreover, the applicability of s19 (1) linking the passing of property to price paid by buyer nullifies the presumption that title passes when the BL is transferred from seller to buyer.
VOB: Sorry Ashish, very knowledgeable, but you are losing me in the technical or should I say legal details. However, what I gather is two key points: One is that it is imperative that contracts are specific on when risk and actual title to the goods pass or change hands; and second if I have understood you correctly is that you maintain in much trade that a bill of lading is not a document of title at all. Am I on track?
AM: You are 100% on track. The contracts in use by trading parties should clearly define the manner in which risk and title pass on from seller to buyer. This will avoid disputes. If passing on the title is not linked to operation of the Bill of Lading but to something else, namely final payment from buyer to seller, then clearly as you infer the BL is not a title document. For example, it is not uncommon for copies of the BL to be used if there is a chain of intermediaries between first and last trading company providing payment or consideration.
VOB: Ok, there is logic in what you say in that if the Bill of Lading is not fulfilling the function of a title document, then copies of the BL may be used as opposed to originals. When you say copies, does that include “photocopies”?
AM: A copy is a copy and a photocopy is a copy or do you disagree?
VOB: I agree – a photocopy is a copy. I don’t think anyone can disagree with that. Just the thought of multiple trades being done on photocopies give me an anxious feeling. Can you give me an example to cure my anxiety?
AM: Suppose there is a party ‘XYZ’ which is an intermediary trading party inserted in the trade chain starting from original supplier to the final buyer. Now ‘XYZ’ makes full payment under the invoice raised by supplier. After making all the due diligence and negotiating the price, it will rely on good faith that supplier has the necessary capacity and authority to supply the goods entered in their contract. On the sales side, ‘XYZ’ receives full consideration. There is no claim raised against ‘XYZ’ by its buyers in any transaction. ‘XYZ” acts both as buyer and seller. It is not carrying out trade as agent. Now, Mr. Vin, would you agree that it is fair to conclude that these are bona fide trade transactions of ‘XYZ”?
VOB: I would agree that it is fair to assume that these are bona fide trade transactions of ‘XYZ”. When you refer to payment for the goods, do you mean payment by direct funds transfer or, for instance, can letters of credit be used?
AM: Naturally payment can be made through funds transfer from buyer to seller but payment may also be structured by negotiation or discounting of usance letters of credit in which case the buyer and seller would have contractually agreed upon this manner of payment as settlement.
VOB: In my experience I am seeing more and more usance letters of credit calling for copy bills of lading, in fact, expressly allowing for photocopy bills of lading. Just wondering, from your perspective on the trading side, is this a common modern day practice derived from logistical challenges?
AM: It is not uncommon to use copy BLs in trades because of the reasoning I just illustrated. Trades which involve use of copy BLs are most often between parties that are inserted/or may get inserted as intermediary parties between original supplier and final buyer. To further illustrate some of the logistical issues, a vessel may take 21 days or so to reach the final port. Most of this cargo is bought and sold by intermediary parties when the cargo is sailing. For practical and logistical purposes, it may not be feasible to have the original BL presented under the import LC of the intermediary trading party since the original BL will be required by the final buyer at the final port of discharge. Does that make sense now – are you up to speed?
VOB: Have no fear, Ashish, I am always up to speed! The example and the way you presented it makes perfect sense and I am sure most of the transactions are bona fide. However, it surely goes without saying that trades structured on usance letters of credit and photocopy bills of lading could facilitate structures where there is no real or genuine underlying trade. Can you suggest some sensible precautions in this context?
AM: I can suggest some precautions based on my own trading experience over many years. Of course this is not legal advice and just based on my own personal insights.
First, it may be desirable wherever possible to make a representation by the contracting parties within the body of the contract itself as regards the status of original BLs. This is to obviate any doubt, suspicion, or worry that may possibly come from bankers and/or other institutions. For instance there could be a statement in the contract (or wording to similar effect): “the shipment was originally effected from Australia by supplier of ABC Ltd and will be delivered at China to the buyers of M/s DEF. The shipment is effected in Chartered Vessel and the transit time from Australia to China is approx. 17 days. In order to avoid delay in receipt of original documents at final buyer’s counters, all original documents have been delivered direct to final buyer in China.”
Second, the insertion of third trading parties or intermediary trading parties should ideally happen before the vessel has been discharged.
Third, it goes without saying that wherever an intermediary party issues a letter of credit and is satisfied with the copy or photocopy of the BL as a presenting document under the LC, it is desirable that the LC should specifically allow for copy BLs to be presented. Ideally, the BL copy should indicate a marking that this is a true copy of the original BL. In such a situation, the copy BL would become credit-compliant and will be consistent with the 1999 ICC Banking Commission - Decision on Determination of an Original Document.
Fourth, as explained earlier, contracts allowing copy BLs should clearly define the transfer of title in goods to be linked to payment from one buyer to the preceding seller.
Finally, the contracting parties should ensure trade and accompanying documents pertaining to the trade are consistent with the laws of the applicable jurisdictions, especially laws relating to intermediary trades (termed merchanting trades in certain jurisdictions like India), for example. The contracts should not be inconsistent with good and standard international trading and banking practices.
VOB: Great practical advice, Ashish, and you are easing my anxiety regarding copy or should I say photocopy bills of lading and usance LCs. However, I still maintain that this bona fide structure you outline could lend itself to abuse to generate nothing other than liquidity where there is no real underlying trade, regardless of how the transactions are window dressed.
AM: That can happen and for sure it does happen to some degree. The relative ease of negotiation or discounting of LCs which allows presentation of copy or photocopy BLs has led to some undesirable practices in some jurisdictions. Bankers often do an International Maritime Bureau (IMB) check to ensure that the BLs (i.e. copies) pertain to actual shipments. However, even if verified, there is no way of knowing if the copies of BLs by the intermediaries in the trade chain were acquired through properly contracted trades so that the title is passing on in the trade chain in a bona fide manner.
VOB: Dear Ashish, your insights are very practical and will be very useful to trade finance professionals who read DCW around the world. I am sure the issue of photocopy bills of lading will continue to pop up in an interesting manner from time to time.
AM: You are most welcome Mr. Vin and I look forward to seeing you at the next ICC Annual Banking Commission Meeting in Dubai in Spring 2020 – if not sooner. ■