Tuesday, July 8, 2014

Estate Planning for Business Owners


It’s something you may hear casually thrown about at the office, or maybe something you even say it to yourself after you barely avoid an accident on your way to work—I need a will.  And while everyone needs a will, small business owners have very special needs that they themselves may not even realize.

Your business, and the value you have built into it, is the greatest asset you can preserve for your heirs.  Surprisingly, many business owners do not have a clear plan of action for how to protect that asset if they should suddenly be “out of the picture.”

First of all, every business owner should incorporate their business into some form of filing entity (corporation, limited liability company, limited partnership, etc.).

Second, every business owner should have a written agreement which controls the governance of their company.  This is especially true if there is more than one equity owner, but still prudent even if owned by a single individual.

Finally, every business owner should have a will which acknowledges and cooperates with the written agreement that controls the business.  Nothing is more frustrating than having to litigate two documents which conflict with each other after the person who signed them is long gone.

When creating these documents you should contemplate the following questions:


1.      Who will run the business after I am deceased?
2.      Who will own the business after I am deceased?
3.      How will the above transfers take place?
4.      Will my business have enough capital to survive the transfer?
5.      Should I integrate life insurance into my business planning?
6.      How will this affect my business partners (if any)?
7.      How will this affect my creditors (loans, lines of credit, etc.)?

Having a defined and well thought out plan, will make a difficult time easier for those you leave behind.  Additionally, the plan will also give you a plan should you suddenly be disabled or otherwise unable to maintain your previous duties, and can also serve as a jumping off point for a retirement plan.  And as all good business plans, they should be made with the advice of financial and legal professionals with very careful consideration given to continued smooth operations. At the Vethan Law Firm, P.C., we work with business owners and financial planning professionals to help them protect and preserve what they’ve built. We assist business owners with choosing the best corporate form for their business, drafting the written agreements that outline and describe management of the business, and work with or recommend financial planning professionals to help ensure the final plan is effective and accomplishes the business owner’s goals. 

Wednesday, July 2, 2014

The Legal Plan To Your Successful Business

Your business is formed.  The organizational paperwork is filed with the state.  You know your products and services, your rate of return, your market, and your brand.  You’ve got the right property leased or purchased for your operations, and you’ve found a great manager.  Your business partner is the best.  Your business plan is solid.  You and your team are working hard and building your dream.  And then it all goes wrong; your “great” manager is suddenly a competitor, taking three key sales employees with him. What went wrong? Most likely the answer will be found in your business’s legal plan, or the lack of such a plan, that documents and organizes the relationships and rights that define and protect your business’s interests.
Nobody knows a business better than the people who intimately grow it.  But building and maintaining a business requires the forethought and devotion of starting and maintaining a family. And a business, like a family, must be prepared for when things go wrong.  For example, do your operations fit the organizational structure you created?  Have employees given access to confidential information signed non-disclosure agreements? Have key managers and sales personnel signed covenants not to compete? Are the rights and obligations of you and your business partners or shareholders clearly defined in company documents, such as shareholder agreements? Have overtime and tax withholding policies been formulated and properly implemented?
A legal plan is a thoughtful review of your policies and procedures to ensure that your methods are sustainable and supported by the stability of the law.  It corresponds to the components of a business plan, in order to support your operations and expectations, to see your business from multiple points of view, and to provide your business with the best protection of the law.  It may be understood in terms of people and relationships with overlapping interests and expectations: 
(1) your customers and your target market;
(2) your suppliers, subcontractors and vendors;
(3) your employees, independent contractors, management and most confident leaders;
(4) your partners or co-owners; and
(5) the sum of it all:  your profits, intellectual property, and tested methods of business. 
            A legal plan will help to sustain your vision, surpass your goals and protect what you have built.  Contracts for purchases and sales should match your expectations.  The roles and responsibilities of the people who work for you must meet the changing mandates of federal labor law, and the regulations of the Texas Workforce Commission.  The trust you put into your managers and senior employees should be protected with non-compete agreements that fit the limitations imposed by Texas law. Your trademarks should fit your activities, and your formational documents should fit the relationships that define your operations. 

A legal plan maintains the structure of a business.  It helps to prevent problems from happening and to minimize unnecessary risk, so that you can build your business.  At the Vethan Law Firm we listen to business owners.  We represent business owners.  It is all we do.  We welcome you to share your needs to plan for your business’s present and future.

Monday, June 23, 2014

Texas’s New Law on Trade Secrets


Prior to the enactment of the Texas Uniform Trade Secrets Act (“TUTSA”), misappropriation of trade secrets was a common-law cause of action, often brought by trade secret owners against individuals who had taken trade secrets and were using or disclosing the trade secrets to the detriment of the owner. Trade secret litigation can be expensive, and under the common law, there was no way for a plaintiff to recover attorney’s fees. However, there was a way around that shortcoming.

Enter Texas’ civil theft statute, known as the Texas Theft Liability Act. The civil theft statute allows an individual to file a civil lawsuit for several different types of theft, such as theft of property or theft of services. Prior to September 1, 2013, it also allowed an individual or business to file a lawsuit for theft of trade secrets.

A key feature of the civil theft statute is that it allows a court to award attorney’s fees to the prevailing party. There are no special requirements, other than that the party prevail. Thus, attorneys representing plaintiffs claiming misappropriation of trade secrets would bring two claims in one lawsuit:  a claim for misappropriation of trade secrets, and a second claim for civil theft.  By filing the civil theft claim, a plaintiff stood a chance of recovering their attorney’s fees if they won the lawsuit.

TUTSA amended the Texas Theft Liability Act, and eliminated theft of trade secrets as a basis for bringing a civil theft lawsuit. Thus, after September 1, 2013, it is no longer possible to bring a civil theft lawsuit in conjunction with a misappropriation of trade secrets case; TUTSA is now the sole remedy in Texas for misappropriation of a trade secret.

TUTSA does allow for attorney’s fees to be recovered, but only in limited circumstances. TUTSA provides that a court may award attorney’s fees to a prevailing party in situations where a lawsuit is brought in “bad faith,” or where a plaintiff proves “willful and malicious misappropriation” by a defendant. While not as broad as the relief provided for by the civil theft statute, TUTSA does appear to recognize that in some circumstances it is unjust to deny a prevailing party the possibility of recouping its attorney’s fees.

As the TUTSA is still in its infancy and has yet to be litigated in many cases, it is important for both Plaintiffs and Defendants in trade secret litigation to be on the cutting edge of legal developments.  Hiring a lawyer who specializes in this area of law is critical for either early success (in the form of prosecuting or defending both Temporary Restraining Orders and Temporary Injunctions) and for success at trial.



Wednesday, May 28, 2014

What are Trade Secrets, and how are they protected?



When most people think of trade secrets, they envision the Coca-Cola secret recipe. Or they think of the KFC's eleven secret herbs and spices. Rarely do business owners take the time to consider what trade secrets their own company may possess. While Coke and KFC's recipes may be famous examples of trade secrets, most companies, in one form or the other, have their own trade secrets that should be valued and protected. 

So what IS a trade secret? What constitutes a trade secret varies based on what industry a company is in. For example, Google's famous algorithm that directs internet travelers to relevant search engine results is an extremely valuable trade secret. A trade secret can include any formula, pattern, compilation, program, device, method, technique, process, financial data, or list of actual or potential customers or suppliers. 

Under the recently passed Texas Uniform Trade Secrets Act ("TUTSA"), to qualify as a trade secret the secret must create independent economic value from not being known or easily ascertainable by others. Stated differently, just having a secret will not create a trade secret. Just as Coca-cola could sell its secret recipe to an interested buyer, the secret must have some real value or potential value. Examples of trade secrets can include everything from client lists, recipes, business plans, future projections, and training, all the way to "negative know-how," which is knowledge that doing things a certain way does NOT work.

Because of differences in industries certain secrets are harder to protect than others. A client list in a highly specialized field is much more protectable as a trade secret than a client list where the customers can easily be identified. The question is how easily can a secret be recreated by a competitor? Similarly, if a secret is something that would be valuable if a competitor learned it, a business owner should attempt to protect it. 

Before TUTSA was passed the factors that courts traditionally considered to determine if something is a trade secret were:

1. The extent to which the information is known outside of the business;

2. The extent to which  the information is known by employees and others involved in the business;

3. The extent of the measures taken to guard the secrecy of the information;

4. The value of the information to the business and to competitors;

5. The amount of effort or money expended in developing the information, and,

6. The ease or difficulty with which the information could be properly acquired or duplicated by others.

After the passage of TUTSA, these traditional factors that courts considered were, in theory, overruled by law. However, with a lack of new cases interpreting the TUTSA law, these factors will most likely still serve as a guide that Courts will consider moving forward. These factors also give a business owner a good way to evaluate how they are protecting their own trade secrets or confidential information.

Even if a business owns a valuable secret, reasonable efforts must be taken to keeps its secrecy. This step may sound simple but most trade secrets are lost by companies because they do not take precautions to keep the valuable secret that gives their business an edge in their industry from walking out the door. 

So how do you protect valuable trade secrets?

The first step that all business owners should take is to determine what information is confidential and valuable to the business and treat it as such. The information should be guarded and limited to only those people who need to know it. This does not require a vault or other extravagant means to accomplish. For example, if the trade secret is digital, make sure that it is password protected. Just as a business owner should not leave cash in an unlocked register, trade secrets that provide value to your company should not be left unprotected. 

One of the simplest steps that a business owner can take to protect their trade secrets is to have employees sign confidentiality agreements. Simple steps like having all employees sign confidentiality agreements, having visitors who are given access to a business’s trade secret sign non-disclosure agreements, and restricting access to confidential information serves two purposes: first, it helps to establish a business’s argument that they have valuable trade secrets, and second, it provides a separate cause of action against a person who violates an agreement, even if a court determines the information was not a trade secret but merely confidential or proprietary.

All business owners in Texas should value their company’s trade secrets and take the time to identify and protect them. Identifying the intellectual property that makes a company more valuable and competitive prevents what is the most common reason for losing trade secret protection: inadvertent disclosure.  If business owners take the time to think of their trade secrets and confidential information as assets of the company with real value, they will better recognize when something threatens that asset. 

The Vethan Law Firm, P.C. is a full service business and trial law firm representing clients in corporate, commercial, trademark, and copyright matters, as well as complex contract and commercial disputes. If you or your business is in need of immediate aggressive representation in a business, commercial or intellectual property law matter, take a moment to meet with us to discuss how we may be of service to you. 

Wednesday, May 21, 2014

Tit for Tat; or why one party’s breach doesn’t mean you can do whatever you would like



It seems to be a common understanding amongst persons that if you enter into an agreement with someone, but they don’t do what they promised in that agreement, then you don’t have to do what you promised.  Unfortunately, that is only partly true.

In the law this common understanding can translate into one of two doctrines.  The first is called “failure of consideration.”  The second is called “prior material breach.”

A failure of consideration occurs when, because of some supervening cause arising after the contract is formed, the promised performance fails.  Cheung-Loon, LLC v. Cergon, Inc., 392 S.W.3d 738, 747 (Tex. App.—Dallas 2012, no pet.).  For example, you enter into a contract to buy a used car over the phone.  However, when you arrive to pick up the car, you find it has (in between the time when you agreed to purchase the car and when you arrived) been struck by lightning burned into cinders and scrap metal.  A total failure of consideration is ground for cancellation or rescission of the contract. Cheung-Loon, LLC v. Cergon, Inc., 392 S.W.3d 738, 748 (Tex. App.—Dallas 2012, no pet.); citing Food Mach. Corp. v. Moon, 165 S.W.2d 773, 775 (Tex.Civ.App.-Amarillo 1942, no writ). In the above example, the loss of the car would be grounds for you to cancel or rescind your deal with the seller.

The doctrine of prior material breach has been described as “a fundamental principle of contract law. Henry v. Masson, 333 S.W.3d 825, 840-41 (Tex. App.—Houston [1st Dist.] 2010, no pet.).

The doctrine provides “that when one party to a contract commits a material breach of that contract, the other party is discharged or excused from further performance.” BFI Waste Sys. of N. Am. v. N. Alamo Water Supply Corp., 251 S.W.3d 30, 30–31 (Tex.2008) (per curiam).  This reflects the common understanding.  However, there is a caveat.

If after the breach, the non-breaching party continues to insist on performance by the party in default, “the previous breach constitutes no excuse for nonperformance on the part of the party not in default and the contract continues in force for the benefit of both parties.” (emphasis added) Chilton Ins. Co. v. Pate & Pate Enters., Inc., 930 S.W.2d 877, 887 (Tex.App.-San Antonio 1996, writ denied) (quoting Houston Belt & Terminal Ry. v. J. Weingarten Inc., 421 S.W.2d 431, 435 (Tex.Civ.App.-Houston [1st Dist.] 1967, writ ref'd n.r.e.)); see also Gupta v. E. Idaho Tumor Inst., Inc., 140 S.W.3d 747, 756 (Tex.App.-Houston [14th Dist.] 2004, pet. denied).

Therefore, if someone has breached an agreement with you, you must elect between two courses of action—continuing performance under the contract or ceasing to perform.

If you treat the contract as continuing after the breach, you will be deprived of any excuse for terminating his own performance. Long Trusts v. Griffin, 222 S.W.3d 412, 415–16 (Tex.2007) (per curiam); Hanks v. GAB Bus. Servs., Inc., 644 S.W.2d 707, 708 (Tex.1982); Gupta, 140 S.W.3d at 756; W. Irrigation Co. v. Reeves Cnty. Land Co., 233 S.W.2d 599, 602 (Tex.Civ.App.-El Paso 1950, no writ).  Alternatively, you may treat the contract as breached and sue for damages.

This may seem common sense, but there is a trap.  What if the agreement is not as simple as buying x for y dollars.  What if there are multiple moving parts, and the seller has only breached one part?

For example, what if you agree to buy a business with no liabilities for $100,000.00 in ten equal monthly payments.  Subsequently, in the first month of operation you discover the business does have liabilities of approximately $10,000.00.  It may seem common sense to simply tell the seller you are offsetting the liability against one of the monthly payments you owe them.  In fact, in many cases the seller will agree to such an accommodation.  However, what if the seller refuses?

The buyer then has two choices: (1) continue to perform, that is, send the ten monthly payments of $10,000.00 as payment for the business and also sue for damages (in this case for $10,000.00); or (2) declare the whole contract in breach and rescind the deal, which would include returning the business and then suing for damages based on loss of the benefit of your original bargain (the value of the business you thought you were buying minus what you agreed to pay for it).  There is no legitimate legally supportable middle ground.  You cannot refuse to make the monthly payment and insist on an offset while retaining the business.  If you refuse to make the monthly payment, you are opening yourself up to liability.  If you elect to treat the contract as continuing after a breach and continue to demand performance, you obligate yourself to perform fully. See Long Trusts, 222 S.W.3d at 415–16.


If you are getting into a high dollar agreement, you ought to have competent legal counsel from the date the first serious offer is made, but when that high dollar agreement has problems you absolutely must have competent legal counsel quickly. Doing otherwise exposes you to unnecessary risk.

Wednesday, May 14, 2014

RECORD IT OR LOSE IT


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The Federal Labor Standards Act (FLSA) is a multi-faceted statute that came into existence at the end of the Great Depression.  That law, which was dormant for several decades, took on new vigor in the past decade, becoming more vigorous with the Great Recession.  The goal of the law is laudable:  provide fair working conditions for employees, and compensate them for the time worked, all within a reasonable work week.  The law created the concept of overtime, to pay non-exempt employees overtime for hours worked in excess of forty hours per week.   However, the FLSA places the burden on employers to track employee time to determine if overtime is warranted.  For many small to mid-sized businesses, especially businesses in the energy and medical services sector, it is one of the most draconian laws targeted at employers.  Many business owners walk into the cross hairs of the FLSA because of simple failing:  inadequate record keeping.

For hourly employees, a business owner must have procedures in place to generate and maintain documentation of the number of hours each employee works each day and each work week (a work week need not be Monday to Friday, but it must encompass a week).  If an employer does not maintain employee time sheets and related documentation, an employee may merely allege the number of hours he or she worked (even the time they spent surfing the internet) – without providing the business owner the opportunity to argue that the employee’s estimates are not accurate.  For a single employee, a business owner’s failure to keep records may cost the business thousands of dollars, and several thousand more in attorney fees.  When employees band together in a class action lawsuit, this can bankrupt an otherwise healthy medium-sized business.

There are exemptions to the FLSA, such as basic categories for some employees who conduct sales or who provide administrative services.  However, FLSA exemptions have limited parameters, and any business owner seeking to claim shelter under them must tailor the employee’s role and responsibilities to the exemption.  Arguing after suit has been filed about possible exemptions, or exemptions thought to exist, is an expensive, slow process that has an excessive and destructive effect on smaller and medium-sized businesses.

To prevent these consequences, there are a few simple first steps in the direction of safety for your business.  Maintain accurate records.  Classify your employees according to their roles and responsibilities.  Pay your employees at least the minimum wage and legal overtime rates.  Make sure that your divisional managers and administrators maintain reliable and consistent records.

At the Vethan Law firm, we are a full-service business law firm.  We work closely with businesses to ensure that their operations match their needs, as well as their policies and procedures, and that their operations fall within the bounds of the FLSA and other laws.  We also work with businesses that have been sued under the FLSA, and counsel companies about available options to defend these lawsuits. 


Wednesday, April 9, 2014

“The Sacred Cow of Equity and Strict Compliance in Letter of Credit Law: Recent Trends and Projections”, an article by VLF’s Managing Attorney Charles M.R. Vethan published in 1994 was recently cited by the Malaysian Bar Association (Bar Malaysia) in Kuala Lumpur. Read the article here:

ARTICLE: Principle Of Strict Compliance In Letter Of Credit (LC): Towards A Proper Standard Of Compliance

By Dr Rosmawani Che Hashim*

ABSTRACT

Principle of strict compliance is significant to sustain the smooth flow of LC procedure. LC expedites payment to a seller as well as guarantees delivery of goods that fulfil contract description to a buyer. However, the issue of standard of compliance causes delays in payment and vitiates the credibility of LC as a method of payment in international trade. Once discrepancies exist in seller’s documents, the documents will be considered as non-compliance and all undertakings are suspended. Consequently, a seller will not receive payment and a buyer will not be able to claim the goods at port of delivery. This paper addresses issues relating to the required standard of compliance from perspective of the UCP 600 and ISBP.

INTRODUCTION

Letter of credit (LC) is a payment mechanism, used to facilitate trade in international sales. One of the fundamental principles governing the LC operation is the principle of strict compliance. The principle requires the seller to present the necessary documents in accordance with LC requirements; in order to claim payment for the goods sold. The principle of strict compliance is defined as the legal principle that entitles the bank to reject documents which did not strictly comply with the terms of LC. [1] The issue of strict compliance comes into the picture during the process of checking documents in LC transactions. The bank is the party responsible in determining whether or not the presentation complies with LC requirements based on the Uniform Custom and Practice for Documentary Credit (UCP 600) and ISBP. The former is the primary rules which govern LC transactions whereas the latter serves as guidelines for the standard interpretation within which the bank must exercise its reasonable judgment in ascertaining the documentary compliance.

The principle of strict compliance aims to protect the buyer who has neither the opportunity to examine the physical goods nor to supervise the process of loading the goods in the seller’s country due to geographical distance. Therefore, the documents are the only security for the buyer. The documents prove that the goods have been properly delivered in accordance with the description in the sale contract.

At the same time, the principle of strict compliance also benefits the seller by providing fast payment. The seller does not have to wait until the goods shipped safely reach the buyer before claiming payment. The seller can claim payment for the goods sold by presenting to the bank the documents required by the buyer once the goods have been shipped to the buyer. Thus, it is essential that the seller’s documents contain a true description of the goods; otherwise the buyer has a right to instruct the bank to reject the documents, which are deemed to be non-compliant.

Apart from the buyer and seller, the bank also benefits from the application of the principle of strict compliance in LC. The bank will be protected against any legal repercussion as long as the payment to the seller was made upon strict compliance of seller’s documents. This is irrespective of the condition of the goods received by the buyer. Since banks usually have limited expertise in goods or industries, they are not expected to know every aspect of commercial terminology in trade, for instance, “coromandel groundnuts” is another trade name for “machineshelled groundnuts kernel.”[2] In most cases, the bank does not even know what kinds of goods are transacted between the seller and the buyer.[3] Hence, even if there is any problem with the goods delivered, the bank will not be held responsible for releasing the payment to the seller as long as the documents are in order. Bank will not be required to ensure that the goods delivered to the buyer meet the specifications in the sale contract.

STANDARD OF COMPLIANCE: A CONFLICT

The well-noted problem regarding the application of the principle of strict compliance in LC is the problem of determining the standard of compliance. Surprisingly, despite being the fundamental principle underlying LC transactions, the requirement for strict compliance is not mentioned in any versions of the UCP.[4] In other words, UCP, being general in nature, does not provide guidelines as to what are the degrees or parameters of discrepancies which would justify the bank to withhold payment on the ground of documentary non-compliance. Until the introduction of the UCP 600, none of the previous revisions of the UCP (including the UCP 1993) provided remedy to the strict compliance issue.[5]

Since there were no standard parameters set by the previous revisions of the UCP, the task of determining the standard of compliance required in documents was left to the courts to decide. Evidently, this loophole has contributed towards conflicts of judgment in case laws as well as uncertainty in banking practices. Over the years, judges and LC experts struggled to come up with a formula to determine the standard of compliance in LC, resulting in diverse opinions and views being formulated. In general, the standard of compliance is divided into literal and substantial compliance standards.[6] The literal compliant standard demands a high standard of compliance. The documents must be in strict compliance with the LC requirements. In other words, it must be the ‘mirror image’ of the LC. This standard suggests that minor mistakes such as typographical errors can be considered as a discrepancy which allows the bank to reject the documents. It is essential in order to protect the banks’ scope of undertaking which is confined to the face of documents only. It also protects the banks from customers’ complaints. Last but not least, it serves the objectives of certainty and reliability of the banker’s credit and guarantees sureness of payment to the beneficiary.

The substantial compliance standard suggests that the presentation of documents which are substantially in compliance with the credit can be accepted as a good presentation. Accordingly, any trivial or non significant discrepancies can be waived. The rationale behind the substantial compliance standard is to promote equity to the beneficiary. It also protects the relationship between bankers and their high valued customer from being affected by minor discrepancies; which results in documentary non-compliance. However, despite its slightly relaxed nature of compliance parameters compared to the literal compliant standard; the substantial compliance standard is not easily practiced. The latter requires skills and in-depth knowledge in order to determine whether to accept or reject the documents tendered. Thus, to certain extent, substantial compliance standard demands the involvement of the bank’s senior or experienced officers to make decisions.[7] Moreover, there are opinions; which claim that substantial standard is inappropriate, controversial and triggers disputes.[8]

However, there are however some LC experts who do not favour the literal and substantial compliance standard classification. They opined that there is no principle of “strict” compliance mentioned in the UCP. The phrase is merely a fiction invented by lawyers drawn from contract law. Moreover, they also alleged that “strict” compliance is not a principle of sound banking.[9] The idea signifies that compliance should be determined based on the documents as a whole with reference to their roles in LC transactions. Regardless of the standard applied, the examination of documents which involves humans checking should not be carried out based on scientific method but it must be realistic. In addition, the question of standard of compliance is subjective and it depends on each individual approach. Some bankers may view the non-compliance on one document as discrepancy while others may look at the content of the requirement and construe it as complying with the LC requirement.

STANDARD OF COMPLIANCE AND THE UCP 600

The current UCP 600 is the result of the ICC Committee’s effort to solve problems relating to strict compliance and documentary discrepancies which arise from the application of the UCP 500. Among the points being painstakingly dissected during the UCP Drafting Group meeting are related to the doctrine of strict compliance and the mechanism to reduce the percentage of rejected documents due to discrepancies.[10] Having realised the high rate of discrepancies found in the seller’s documents, the ICC working groups came up with the new UCP 600. The new version aims to reduce the strict requirements imposed by the UCP 500 on documents. Various views and comments on the current rules in the UCP 600 portray it as more customer-friendly and an easier reference compared to the earlier UCP version.[11]

The UCP 600 still maintains its general nature. It does not highlight objectively the criterion that constitutes compliance or otherwise. The current UCP through the provision of Article 16(b) seems to be the mechanism to pass over the bulk of documents to the trading parties ie, the seller and the buyer to finally determine whether or not to accept the discrepant documents. Yet, the word “may” of Article 16 (b) implies that the bank retains a discretionary authority whether to refer the notified discrepancies to the applicant or not.[12]

Despite the generality of the rules, UCP 600 contains provisos which clarify the previous provisions of documentary compliance. It also introduces new articles including those which provide definitions of presentation and complying presentation. As an example, complying presentation is defined as:

a presentation that is in accordance with the terms and conditions of the credit, the applicable provisions of the UCP rules and international standard.[13]

The above clarification removes the existing perceptions of compliant documents.[14] It states that the compliance of documents is not only determined by LC requirements and the rules of the UCP rules; it must also be guided by the International Standard Banking Practice. (ISBP).

The doctrine of strict compliance has been relaxed by the provisions introduced by the UCP 600.[15] It is stated in Article 14(d), UCP 600:

Data in document, when read in context with the credit, the document itself and international standard banking practice, need not be identical to, but must not conflict with, data in that document, any other stipulated documents or credit.”

The above provision eliminates the narrow provision of Article 13(a) of the UCP 500, which stated that documents which are “inconsistent with one another,” will be treated as non-compliant. The introduction of the new provision by the UCP 600 reduces the complexity presented by the strict compliance principle. It signifies that as long as the contents of the documents are not contrary to the LC, the bank will accept documents as in compliance. The requirement that the content of the seller’s documents “need not be identical to, but must not conflict” eliminates conflicts between different documents, which is the most frequent ground for the dishonour of documents presented under commercial LCs. Likewise, the application of this current rule has lessened the seller’s burden relating to documentary compliance. In other words, leeway accorded by the UCP 600 will be able to minimise the volume of discrepancies in documents presented by the seller as the requirement for compliance becomes simpler and easier to perform. It gives the bankers a greater degree of flexibility that should result in fewer discrepancies and rejections.[16] This provision however does not objectively state the criteria of compliance. While it undoubtedly implies a wider compliance approach, it however opens up room for potential new disputes; for example, to what extent the data is not in conflict with each other.

Another provision in the UCP 600 that comforts the seller is Article 14(e) which allows the goods in all documents (other than the commercial invoice) to be described in general and not be in conflict with LC requirements.[17] Furthermore, Article 14(j) provides that addresses of the beneficiary and applicant need not be the same as those in the credit, provided that they are in the same respective country. Thus, in the present position under the UCP 600, such non-compliance is no longer considered as discrepancy.

However, notwithstanding the tolerance offered by the UCP 600, it does not promise absolute leniency for the seller. The requirement of strict compliance still remains in Article 18(c) relating to the description of the goods in a commercial invoice. It states:

The description of the goods, services or performance in a commercial invoice must correspond with that appearing in the credit.”

The above provision expressly maintains the requirement of strict compliance in commercial invoice. Generally, the leniency offered by the UCP 600 to other LC documents[18] and addresses[19] are not extended to commercial invoice since the phrase “must correspond” with the requirement of LC in Article 37(c) of the previous UCP 500 is still maintained. However, by virtue of Article 14(d) above, the phrase “must correspond” should be construed within the meaning of this provision, which offers less rigidity in documentary compliance.

Furthermore, the UCP 600 offers some leniencies and protections for bankers. The emergence of Article 16 of the UCP 600 has eased the tension suffered by banks in dealing with discrepant documents. The rule allows the bank to practice ‘conditional refusal.’ This procedure makes the bank’s duty to justify acceptance or refusal of the documents much easier.[20] The bank may refuse to honor the draft under an LC if the presentation of the documents is not compliant.[21] In doing so, the bank must notify the presenter by giving a notice of refusal. [22] The notice must be given by telecommunication or by any expeditious means no later than the close of the fifth banking day following the day of presentation. [23]The notice must state that:

(i) the bank has refused to honour

(ii) list down each discrepancy

(iii)       (a) the bank is holding the documents pending further instruction from
     the presenter;

or,

(b) the issuing bank has requested a waiver of the discrepancies from  
     the applicant and is holding the documents until it receives such a
     waiver and accepts it, or receives further instructions from the
     presenter prior to agreeing to accept a waiver,
or

(c) the bank is returning the documents;
or

(d) the bank is acting in accordance with instructions previously
     received from the presenter.[24]

Failure by the bank to state clearly in the notice its refusal and rejection of the presentation of documents may preclude the bank from exercising its right of rejection. Merely sending a notice from the bank to acknowledge the discrepancies is not sufficient to constitute rejection. [25] In addition, the UCP 600 provides disclaimers for the banks to protect them from any difficulties arising out of the documents and performance of LC transactions.[26]

Furthermore, this Article bestows mercy on the seller since he would have known whether or not the documents are discrepant and allows him to provide prior instructions to the issuing bank, and the buyer would have also been contacted before the documents arrived.[27]

STANDARD OF COMPLIANCE AND THE ISBP

Apart from the UCP, another important reference that guides the banks in determining the international standard to be used in checking documents is the ISBP.[28] The latest version is the ISBP 2013, ICC Publication No. 745. Thus far, the ISBP, which aims to reduce the number of documents rejected by banks, has already played a significant role in reducing international discrepancies. It contains a list of general principles relating to the standard practices for determining documentary compliance. The ISBP is referred to in cases whereby the rules of the UCP need clarification.[29] The ISBP allows the transaction to continue in a normal way without hindering it. This has definitely contributed a lot in reducing discrepancies since the ISBP requires substantial compliance instead of strict literal compliance. It is basically done by examining the documents and neglecting minor non-compliance to be regarded as discrepancies.

However, it should be noted that the requirement that a presentation must be in accordance to the ISBP is not mandatory. Banks may only adopt the ISBP for clarification. They cannot rely only on the ISBP in deciding whether to reject or accept the presentation as it must be solely based on the UCP alone.

CONCLUSION

The application of the principle of strict compliance may put the buyer in difficulty if the seller’s documents are rejected for non-compliance. The buyer in such a case needs to wait for the seller to rectify the rejected documents since the buyer has to possess the documents to take delivery of the goods. This delay may affect the buyer’s business schedule and causes him to lose his business profit. Even though the buyer has the right to waive the discrepancies, in practice, the final say in most cases is still with the bank.

Obviously, the hindrance caused by the discrepancies of documents produces negative impact on the LC as a means of payment. This phenomenon should not be ignored as it affects the LC’s integrity as a recognised means of settlement in international trade. Once a document is found to contain discrepancies, the whole process is likely to be deferred. Such discrepancies trigger unnecessary hiccups, which may be temporary or permanent in the flow of LC procedures. In most cases, noncompliance disputes will open a leeway to court proceedings. The delays may definitely be prolonged as the litigation continues. In worse situations, delay of payment may end up causing possible loss of future trade.

The existence of the latest UCP 600 is claimed to provide leniency and a higher degree of compromise to the strict compliance principle. Wider strict compliance as suggested by the UCP 600 does not mean that the data content in any documents could go ‘unmatched’. Generally, it only widens the scope of compliance where data in any document may differ expressly with one another but should not contradict each other. This is in line with the different purposes and functions of each document where the express wording contained in any one document may slightly differ with the expressed wording in other documents. This new approach of compliance is seen to ensure smoother payment under the LC rather than looking for discrepancies and rejecting such discrepant documents during the process of document examination.

In short, the current UCP 600 limits the depth of examination of documents by banks and provides leniency in resolving issues on discrepant documents where the trading parties, namely the buyer and the seller, equally have some binding say on how the discrepant documents should be dealt with. Generally, as far as ‘compliance’ is concerned, the UCP 600 can be said to encourage fair and equitable trade. Nevertheless, it is alleged that the adoption does not totally eradicate issues of compliance of documents in LC since the examination process of documents involves human intervention.[30] Therefore, discrepancies cannot be avoided completely no matter how well the UCP is written.’[31]

*Senior Lecturer, Department of Policy and Business Strategy, Faculty of Business
and Accountancy, University of Malaya.

This article first appeared in CLJ [2013] 1 LNS(A)lix and is reproduced with permission from the Author.

Endnotes:
[1] Alan Davidson, “Commercial Laws in Conflict - An Application of the Autonomy Principle in Letters of Credit,” 6 Int'l. Trade & Bus. L. Ann. 65 (2001).
[2] See, J.H. Rayner Co Ltd v. Hambro’s Bank Ltd [1943] K.B. 37.
[3] See, Power Cuber International Ltd v. National Bank of Kuwait (1981) 1 WLR 1233, per Lord Denning MR, at 1241.
[4] Ravi Mehta, Does UCP 600 Soften or End the Doctrine for Strict Compliance? LC Views, Newsletter No. 101, March 2007.
[5] Charles M.R. Vethan, “The Sacred Cow of Equity and Strict Compliance in Letter of Credit Law: Recent Trends and Projections,” (1994), 6-SPG Int’l Legal Persp. 45, at 48.
[6] See, TomPifer, “Note and Comment: The ICC Publication of International Standard Banking Practice (ISBP) and the Probable Effect on United States,” (2006) 12 Tex, Wesleyan L. Rev. 631, at 637-640; Steven C. Rattner, “Letters of Credit: A Return to the Historical Documentary Compliance Standard,” (1984-1985) 46 U. Pitt. L. Rev. 457, Boris Kozolchyk,“Strict Compliance and the Reasonable Document Checker,” (1990-1991) 56 Brook. L. Rev. 45 Vol. 56, Issue 1.
[7] Ravi Mehta, Does UCP 600 Soften or End the Doctrine for Strict Compliance? LC
Views, Newsletter No. 101, March 2007, viewed on 18April 2009.
[8] See, Mohamed Ibrahim M Adam, The Problem Relating to The Interpretation of
Strict Compliance Rule In Letters of Credits Practice, May 13, 2006, viewed 10 June 2012.
[9] Byrne, James E, School of Law, University of George Mason, USA (Interviewed by author, Kuala Lumpur, 21 July 2009).
[10] See, Charles Debattista, “The New UCP 600 - Changes to the Tender of the Seller’s Shipping Documents under Letters of Credit,” (2007) J.B.L., JUN, 329-354, at 2.
[11] Janet Ulp, “The UCP 600: Documentary Credits in the 21 st Century,” (2007) J.B.L. 35 at 376-377; See also, Commodities Finance Impact of UCP 600, A Guide to the New Rules, Reed Smith Richards Butler LLP (2007), An ICC Banking Commission Market Intelligence Report, at 27.
[12] It is reported that 11% of the bankers return discrepant documents without first seeking a waiver from the applicant; See, Gary Collier “Summary Assessment,” An ICC Global Survey, Rethinking Trade Finance, 2010, at 12; See also, Sara Younger, “The Reality of the Strict Rule,” DCINSIGHT, Vol. 16 No 1, January-March 2010, at 14. For legal interpretation of a word “may”, see also, Nicholl v. Allen [1862] 31 LJ QB 283; Cooper v. Hall [1968] 1 WLR 360.
[13] Article 2, UCP 600.
[14] See, Bergami, “What Can UCP 600 Do For You?” (2007) 11 VJ 1, at 1.
[15] See, Alan M. Christenfield & W. Melzer Shepard, New Rules for Letters of Credit, New York Law Journal, Thursday, February 1, 2007.
[16] Roberto, Bergami, Will the UCP 600 Provide Solutions to Letter of Credit Transactions? (June, 2007), Vol. 3, No. 2, International Review of Business Research Papers, at 41-53.
[17] Paul Todd, Bills of Lading and Bankers’ Documentary Credits, 4th Edition, Informa, London, 2007, at 281.
[18] Article 14(e), UCP 600.
[19] Article 14(j), UCP 600.
[20] The new Article 16 of the UCP 600 has modified the terms of Article 14 of the UCP 500 in dealing with discrepant documents.
[21] See, Article 16(a), UCP 600.
[22] Article 16(c), UCP 600. See also, Reinhard, Langerich, “An Improved UCP that Has Solved Many Problems,”DCINSIGHT, January-March 2007, at 3.
[23] Article 16(d), UCP 600.
[24] Article 16(c), UCP 600.
[25] See, Voest-Alphine Trading U.S.A Corp. v. Bank of China, 142 F.3d 887 (5th Cir. June 12, 1998).
[26] See, Articles 34, 35, 36 and 37, UCP 600.
[27] See, Langerich, n 23.
[28] Bergami, “What Can UCP 600 Do For You?” (2007) n 14 at 4.
[29] For instance, the issues of what constitute discrepancy or non-compliance can be guided by the provisions of Rule 23, definition of invoice by Rules C1-C2 and description of goods by Rules C3-C14, ISBP.
[30] See, Janet Ulp, “The UCP 600: Documentary Credits in the 21st Century,” (2007) J.B.L. Jun, 367; Gary Collyer, DCINSIGHT, Vol. 15.4, October-December 2009, at 3.

[31] See, LC Views, Interview with T.O. Lee, 2 April, 2006.