Acceptance "under reserve" in credit transactions
Alan L Tyree

A bank that issues or confirms a documentary credit is only obliged to pay if the documents conform strictly to the terms of the credit. When faced with a presentation of documents that the bank believes to be non-complying, the bank has several options. It may simply reject the documents and refuse payment.

However, the beneficiary may be a customer, and the bank may desire to be accommodating. This is particularly true if the deficiencies in the documentation seem to be minor or if there is some reason to believe that the buyer will waive the discrepancies.

In this case, the bank might advance payment, but will wish to protect itself in some way. It is common to seek a letter of indemnity by which the beneficiary, in consideration of the payment being made notwithstanding the irregularities, promises to indemnify the confirming bank against any loss it may suffer by reason of so paying.

The third option is to make payment "under reserve". In this form, the bank advances payment either in whole or in part, but "reserves" certain discrepancies. It then forwards the documents to the issuing bank with the hope that it will accept the presentation as complying or will obtain a waiver from the credit applicant with respect to the stated discrepancies.

The procedure, although common, holds danger for the bank that advances funds, for it may prove difficult to recover the funds in the event that the issuing bank does not accept the documents and is unable to obtain a waiver from the applicant.

The meaning of the phrase "payment under reserve" was first judicially considered in Banque de l'Indochine et de Suez SA v J H Rayner (Mincing Lane) Ltd [1983] QB 711.

The judgment of Parker J is complicated by the fact that, at the time, money payable under a mistake of law could not be recovered. This old, and anomalous, rule was established, probably erroneously, by Lord Ellenborough CJ in Bilbie v Lumley (1802) 2 East 469; 102 ER 448. In Australia, the rule was abolished by the High Court in David Securities v Commonwealth Bank of Australia (1992) 175 CLR 353.

In the Banque de l'Indochine case, the confirming bank believed that the documents were non-conforming on a variety of grounds. Following a telephone conversation, the bank arranged payment "under reserve". There was no indication in the documentation about the meaning of the phrase. The credit incorporated the terms of the Uniform Customs and Practice for Documentary Credits (the UCP), 1974 revision.

The 1974 revision did not define the phrase "under reserve" although Article 8(g) provided that:

If the remitting bank draws the attention of the issuing bank to any irregularities in the documents or advises such bank that it has paid, accepted or negotiated under reserve or against a guarantee in respect of such irregularities, the issuing bank shall not thereby be relieved from any of its obligations under this article. Such guarantee or reserve concerns only the relations between the remitting bank and the beneficiary.

The bank contacted the issuing bank, notifying that it had made payment under reserve with respect to a number of discrepancies. The issuing bank contacted the buyers who refused to waive the discrepancies, and the issuing bank then rejected the documents.

It seemed to be common ground that the bank could recover the payment "under reserve" if the discrepancies in the documentation justified the issuing bank in rejecting the documents. The problem in the Banque de l'Indochine case was that the beneficiary believed that the presentation was a complying presentation, and so refused to refund the payment.

Parker J offered two interpretations of the phrase "payment under reserve".

• the bank should be entitled to repayment even if it was in law obliged to pay when it did, that is, even if the bank was wrong about the non-conformity of the document;
• the bank should be entitled to repayment if one or more of the irregularities was, in law, a reason that the bank could have refused to pay.

Of course, the only way to determine if the documents should have been accepted was to litigate the matter. If the first interpretation was held to be correct, then the beneficiary would have to initiate litigation to obtain payment. If the second interpretation was correct, then the bank would have to initiate litigation to recover its advance payment.

Parker J rejected, at 716, the first as being more than a "reservation" since it creates a right to recover money that was contractually payable at the time payment was made.

The effect of the second interpretation is to prevent the beneficiary from resisting a demand for repayment of money paid under a mistake of law. To understand this, suppose that the funds had been paid without the reservation. When it was later discovered that the funds had been mistakenly paid, the bank would sue to recover as a payment made under a mistake. However, the mistake is one of law and therefore, at the time in question, not recoverable. The "under reserve" gives the bank the right, under the second interpretation, to recover.

In accepting the second interpretation, Parker J had then to consider if the documents constituted a complying presentation. He held that they did not, and therefore the bank was entitled to the return of the funds.

The defendants appealed. In the Court of Appeal, Sir John Donaldson MR considered that the view of the lower court was a "lawyer's view" since it contemplated that the parties were concerned primarily with the inability to recover money paid under a mistake of law. The Court of Appeal held that the phrase had the first meaning, that the bank could recover if the issuing bank refused to pay against the documents, either on its own initiative or under instructions from the buyer.

This has been criticised as leaving the seller in the unenviable position of having to sue the confirming and/or issuing banks if the seller believes that the documents conform to the credit. However, that is the same position that the seller would be in if the bank had not paid "under reserve" but simply rejected the documents. The situation only arises if the confirming bank and the issuing bank believe that the documents do not conform. Instead of payment "under reserve", the bank could simply have rejected the documents and refused payment.

The broad terms given to the meaning "under reserve" also raised fears that the buyer could manipulate the situation by giving instructions to reject the document. This fear arose partly because of the definition given by Kerr LJ (at 734):

What the parties meant, I think, was that payment was to be made under reserve in the sense that the beneficiary would be bound to repay the money on demand if the issuing bank should reject the documents, whether on its own initiative or on the buyer's instructions.

This led to speculation that when the confirming bank accepted "under reserve" that the issuing bank could avoid its fundamental obligations if the buyer instructed it to reject the documents. This fear is also unfounded since the final sentence of Article 8(g) of the 1974 revision shows that the phrase does not alter the obligations of the issuing or confirming banks.

Sir John Donaldson MR suggested that (at 727):

In the longer term the International Chamber of Commerce, who are the authors and guardians of the Uniform Customs and Practice for Documentary Credits might like to turn their minds to this problem [the meaning of "payment under reserve"] when undertaking the next revision.

The suggestion was not acted upon. The UCP was revised in 1983, 1993 and 2007. Article 16(f) of the 1983 revision, known as the UCP400, retains the former Article 8(g) except it replaces "guarantee" by "indemnity". Article 14(f) of the 1993 revision, known as the UCP500, is in terms substantially the same as Article 16(f) of the 1983 revision.

The 2007 revision of the UCP, the UCP600, has dropped all reference to payment "under reserve". However, the obligations of the bank which receives the documents are specified in greater detail. In all cases, a bank which decides that the documents are non-complying must give a notice to the presenter. The notice must state that the bank is refusing to honour or negotiate, and it must state each discrepancy in respect of which it refuses the documents.

In addition, the notice must inform the presenter of the way in which the bank intends to deal with the documents.

The UCP500, in keeping with earlier revisions, provided that a bank which decided to refuse the documents must either:

• hold the documents at the disposal of the presenter; or
• return the document to the presenter.

The UCP600 adds two further options:

• the issuing bank is holding the documents until it receives a waiver from the applicant and agrees to accept it, or receives further instructions from the presenter prior to agreeing to accept a waiver; or
• the bank is acting in accordance with instructions previously received from the presenter.

The first of the new options is the one most suitable for a bank which has made a payment "under reserve" to the beneficiary. However, the UCP600 does not specifically deal with the problem of recovering the money from a beneficiary who has received an advancement.

These notice requirements, set out in Article 16, are very important. An issuing bank or a confirming bank that fails to give the notice is precluded from claiming the the documents do not constitute a complying presentation: Art 16(f).

The end result is that the bank's position when advancing funds "under reserve" is governed by the rule in Banque de l'Indochine et de Suez SA v J H Rayner (Mincing Lane) Ltd [1983] QB 711, assuming that an Australian court would follow that decision. It is submitted that it would do so.

The result is not entirely satisfactory, but there should be little trouble if the documentation spells out the meaning of "under reserve". The documentation should make it clear that rejection for any reason by the issuing bank causes the advanced funds to be immediately due and payable. Anything less than such very clear terms is asking for trouble.