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Banking Interpretations

NYSBL 96(1) and 96(2) and 200

March 17, 2006 11:38 AM

Rosanne Notaro/legal/NYSBD

To "Levin, Jonathan L."
cc Sara Kelsey/legal/NYSBD@NYSBD, ChristineTomczak/legal/NYSBD@NYSBD
Subject Re: Independent undertakings

Dear Mr. Levin,

In your email inquiry to Sara Kelsey of March 9, 2005, you asked whether New York state-chartered banks and branches of foreign banks have the same authority as national banks to issue letters of credit and other independent undertakings to pay against documents.

In particular, you refer to the authority for national banks set forth in the regulations of the Comptroller of the Currency ("OCC") at 12 C.F.R. 7.1016 (I note that in your email this reference is mistakenly cited as 12 C.F.R. 7.7016). 12 C.F.R. 7.1016 provides in part:

"A national bank may issue and commit to issue letters of credit and other independent undertakings within the scope of the applicable laws or rules of practice recognized by law. Under such letters of credit and other independent undertakings, the bank's obligation to honor depends upon the presentation of specified documents and not upon nondocumentary conditions or resolution of questions of law or fact at issue between the applicant and the beneficiary. A national bank may also confirm or otherwise undertake to purchase specified documents upon their presentation under another person's independent undertaking within the scope of such laws or rules."

The quoted passage in the preceding paragraph carries a footnote, which cites a list of laws and rules of practice. In your email, you offer several excerpts from the list of laws and rules of practice demonstrating the nature and variety of these transactions as they routinely occur in domestic and international commerce. I will not repeat those excerpts here, as they are extensive, but I incorporate them by reference for purposes of this response. The excerpts you quoted appear to demonstrate that "independent undertakings" are very similar, if not in some cases identical, to letters of credit, in that they are a bank's obligation to honor a commitment based on the presentation of documentary evidence. You also reference the OCC's safety and soundness considerations required to be observed by banks issuing independent undertakings, and they are very similar or identical to those that banking regulators typically look for in connection with banks' issuances of letters of credit.

It is the Department's opinion that New York state-chartered banks, as well as New York state-licensed branches and agencies of foreign banks, have the same authority as national banks, as set forth in 12 C.F.R. 7.1016, to issue letters of credit and other independent undertakings to pay against documents. Banking Law Section 96(2) authorizes state-chartered banks to issue letters of credit and Banking Law Section 96(1) generally authorizes state-chartered banks to engage in activities incidental to banking. Together, these sections would authorize the above-described activities for state-chartered banks. The powers (aside from deposit-taking) of state-licensed branches and agencies of foreign banks to engage in the business of banking, although not enumerated in detail in Banking Law Section 200, as a general rule, are intepreted by the Department to be co-extensive with those of state-chartered commercial banks.

Accordingly, we believe that the above-described letter of credit and independent undertaking activities are also authorized for state-licensed branches and agencies of foreign banks.

I hope that this is helpful.

Sincerely,

Rosanne Notaro
First Assistant Counsel


03/09/2006 06:16 PM

"Levin, Jonathan L." <JLevin@ReedSmith.com>

To <sara.kelsey@banking.state.ny.us>
cc <rosanne.notaro@banking.state.ny.us>
Subject Independent undertakings

Dear Ms. Kelsey,

I am writing to confirm the matters I discussed yesterday by telephone with Rosanne Notaro and Christine Tomczak and to submit a formal request to the New York State Banking Department for an answer to the following question:

Do New York state-chartered banks, including state-chartered branches of foreign banks, have the same authority as national banks to issue letters of credit and other independent undertakings to pay against documents?

To reach this ultimate question, I began my research at 12 CFR § 7.7016, the OCC regulation authorizing national banks "to issue and commit to issue letters of credit and other independent undertakings within the scope of the applicable laws or rules of practice recognized by law." The regulation proceeds to describe these transactions as having the bank's obligation to honor depend solely upon the presentation of specified documents and not upon nondocumentary conditions or resolution of questions of fact or law at issue between the applicant and the beneficiary.

The quoted passage in the preceding paragraph carries a footnote, which cites a list of laws and rules of practice. In the interest of demonstrating the nature and variety of these transactions as they routinely occur in domestic and international commerce, I offer the following excerpts.

Uniform Commercial Code- Article 5

 Article 5 of the Uniform Commercial Code defines letter of credit as:

"Undertaking by an issuer to a beneficiary at the request or for the account of an applicant or, in the case of a financial institution, to itself or for its own account, to honor a documentary presentation by payment or delivery of an item of value...Letters of credits may be issued in "any form that is a record and is authenticated (i) by a signature or (ii) in accordance with the agreement of the parties or the standard practice." Emphasis added.]

The Uniform Customs and Practice for Documentary Credits

Article 2 of The Uniform Customs and Practice for Documentary Credits states:

"For the purposes of these Articles, the expressions "Documentary Credits(s)" and "Standby Letter(s) of Credit" (hereinafter referred to as "Credit(s)", mean any arrangement, however named or described, whereby a bank (the "Issuing Bank") acting at the request and on the instructions of a customer (the "Applicant") or on its own behalf, (i.) is to make a payment to or to the order of a third party (the "Beneficiary"), or is to accept and pay bills of exchange (Draft(s)) drawn by the Beneficiary, or (ii.) authorizes another bank to effect such payment, or to accept and pay such bills of exchange(Draft(s)), or (iii.) authorizes another bank to negotiate, against stipulated documents(s), provided that the terms and conditions of the Credit are complied with. For the purposes of these Articles, branches of a bank in different countries are considered another bank." [Emphasis added.]

The International Standby Practices

Although letters of credit are not explicitly defined within the "The International Standby Practices," the description of Standby Letters of Credit , found within the "Scope and Application" section of the treatise states:

"A standby letter of credit or other similar undertaking, however named or described , whether for domestic or international use, may be made subject to these Rules by express reference to them. Additionally, the section entitled "Nature of Standby" states that "a standby is an irrevocable, independent, documentary, and binding undertaking when issued and need not so state." [Emphasis added.]

The United Nations Convention on Independent Guarantees and Stand-by Letters of Credit

 This treatise stipulates that an undertaking is also known as an "independent guarantee" or "stand-by letter of credit," about which it instructs:

"Stand-by letters of credit provide assurance of payment in a wide variety of commercial settings ranging from backing up performance of undertakings to enhancing capital market offerings. As such, they have come to play a vital role in commerce, one which exceeds exponentially the better-known (and related) workhorse of international payments, the commercial letter of credit. In the United States , where stand-bys originated, their estimated volume of approximately USD 400 billion evidences the relative efficiency and market confidence which they command." [Emphasis added.]

Uniform Rules of Bank-to- Bank Reimbursements Under Documentary Credits

 The term "Reimbursement Undertaking" is pivotal to this treatise and appears in the definitions section as:

A separate irrevocable undertaking of the Reimbursing Bank, issued upon the authorisation or request of the Issuing Bank to the Claiming Bank named in the Reimbursement Authorisation, to honour that bank's Reimbursement Claim provided the terms and conditions of the Reimbursement Undertaking have been complied with. [Emphasis added.]

A "Reimbursement Authorisation" is defined to mean an

"instruction and/or authorisation, independent of the Credit, issued by an Issuing Bank to a Reimbursing Bank to reimburse a Claiming Bank, or, if so requested by the Issuing Bank, to accept and pay a time draft(s) drawn on the Reimbursing Bank." [Emphasis added.]

Next, I determined that a Federal branch is authorized to enter into these types of transactions to the same extent as a national bank. Pursuant to 12 CFR § 28.13, "the operations of a foreign bank at a Federal branch or agency shall be conducted with the same rights and privileges and subject to the same duties, restrictions, penalties, liabilities, conditions, and limitations that would apply if the Federal branch or agency were a national bank operating at the same location."

Finally, I examined the standards established by the Federal Reserve Board for activities of state-chartered branches. Under Regulation K, at 12 CFR § 211.29(b)(2), no application to the Fed is required "by any state branch or state agency to conduct any activity that is otherwise permissible under applicable state and federal law or regulation that: ***** (2) Is permissible for a federal branch, but the Comptroller imposes a quantitative limitation on the conduct of the activity by the federal branch." Since this provision is set within the context of activities that are not permissible for federal branches, it seems possible that an activity, such as issuance of letters of credit and other independent undertakings, that is permissible for a Federal branch may also be permissible for a state branch. The International Banking Act of 1978 presents the concept in the negative: "...a State branch or State agency may not engage in any type of activity that is not permissible for a Federal branch..." 12 USC § 3105(h)(1).

However federal law may ultimately be interpreted (and I have not conducted exhaustive research into case law), I would prefer to have a clear idea of the New York State Banking Department position on the authority of its banks to engage in the activities here at issue.

As an addendum, in response to a request by Ms. Notaro and Ms. Tomczak, I also provide below the safety and soundness considerations that the OCC places upon transactions involving letters of credit and other independent undertakings, as set forth in 12 CFR § 7.1016(b):

Safety and soundness considerations

  1. Terms. As a matter of safe and sound banking practice, banks that issue independent undertakings should not be exposed to undue risk. At a minimum, banks should consider the following
    1. The independent character of the undertaking should be apparent from its terms (such as terms that subject it to laws or rules providing for its independent character);
    2. The undertaking should be limited in amount;
    3. The undertaking should:
      1. Be limited in duration; or
      2. Permit the bank to terminate the undertaking either on a periodic basis (consistent with the banks ability to make any necessary credit assessments) or at will upon either notice or payment to the beneficiary or
      3. Entitle the bank to cash collateral from the applicant on demand (with a right to accelerate the applicant obligations, as appropriate); and
    4. The bank either should be fully collateralized or have a post-honor right of reimbursement from the applicant or from another issuer of an independent undertaking Alternatively, if the bank's undertaking is to purchase documents of title, securities, or other valuable documents, the bank should obtain a first priority right to realize on the documents if the bank is not otherwise to be reimbursed.
  2. Additional considerations in special circumstances. Certain undertakings require particular protections against credit, operational, and market risk
    1. In the event that the undertaking is to honor by delivery of an item of value other than money the bank should ensure that market fluctuations that affect the value of the item will not cause the bank to assume undue market risk
    2. In the event that the undertaking provides for automatic renewal, the terms for renewal should be consistent with the bank's ability to make any necessary credit assessments prior to renewal;
    3. In the event that a bank issues an undertaking for its own account, the underlying transaction for which it is issued must be within the banks authority and comply with any safety and soundness requirements applicable to that transaction.
  3. Operational expertise. The bank should possess operational expertise that is commensurate with the sophistication of its independent undertaking activities.
  4. Documentation. The bank must accurately reflect the banks undertakings in its records, including any acceptance or deferred payment or other absolute obligation arising out of its contingent undertaking

Thank you for your consideration of this matter. I would greatly appreciate an expedited response.

Jonathan L. Levin

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