China - Ante-Dated Bills - Freezing Orders For Payments Under Letters Of Credit

June 2004

AN evolving issue in China trades which is of concern to shipowners, traders and bankers alike is the frequency of freezing orders by Chinese courts over payments under letters of credit. 

The two problem areas are ante-dated bills of lading (a potential nightmare for shipowners) and allegedly discrepant documents (a more manageable problem under the Uniform Customs and Practice for Documentary Credits but nevertheless a headache for traders and bankers). 

Freezing orders where the Chinese courts order local banks not to make payments under irrevocable letters of credit arise under China's relatively recent Maritime Procedure Law which came into force in July 2000.

Provisions of that law allow the maritime courts in China to take compulsory steps to "preserve or seal up evidence" before trial. Although straightforward, this provision has the potential to become a Trojan horse in the documentary credit system of China. Relying on the Maritime Procedure Law, the Chinese maritime courts will readily accept applications for evidence preservation, and judges will attend on board themselves when a ship arrives in China to investigate whether bills of lading have been backdated. 

If there is evidence that loading was not completed by the date shown on the bill of lading, fraud will be presumed to have occurred and the court may issue a freezing order. 

Of course, if the beneficiary of a letter of credit has been complicit in the issuance of an ante-dated bill of lading, then he has been guilty of fraud and may well not be entitled to collect under the credit. 

However, it is often the case that the beneficiary of the letter of credit is unaware of the ante-dating, say, when he is an intermediate holder of the bill of lading in a chain of sale or when the shipowner backdates the bill of lading to meet the required shipment date. 

Furthermore, in most systems of law, fraud is an allegation that must be strictly proved and it is not possible to invoke the powers of the courts on the bare allegation that fraud has occurred. 

While perhaps fine in theory, the ease with which freezing orders can be obtained from the Chinese courts have left the system open to abuse. 

There have been two recent high water marks in China involving freezing orders over letters of credit. 

The most recent occurred last summer when numerous orders were issued involving steel shipments to China. At that time, steel prices had dropped substantially. The problem was severe enough that it prompted the International Maritime Bureau to issue a press release last May. This stated in part: "The IMB says that the value of rejected documents relating to steel shipments to China is now in excess of US$100m. These losses are primarily with respect to letters of credit payable at sight or deferred for a maximum of 90 days... " 

The development coincides with the recent drop in the steel market. 

In the past few months, steel prices have plummeted 15%-20%. A similar problem arose a few years ago when the Chinese soya bean market collapsed. 

The rejected steel document cases are still wending their way through the Chinese courts. Similar cases in the chemical and other soft commodity trades have also been seen. 

Steps have been taken in China to attempt to address the issue and perhaps correct the balance. In July last year, the Supreme People's Court in Beijing issued a notice to all subordinate courts including the maritime courts concerning the problem. 

The notice emphasised the importance of the documentary credit system and the faith international counterparts must have in Chinese banks. It set further guidelines on the fraud exception stating as follows:

"This year, the international steel market has dropped considerably. This has influenced internal steel product prices which have also fallen... some import merchants have requested banks to refuse payment on the basis of discrepant documents or have applied to court on the basis of so called 'fraud' to stop payment under letters of credit.

 "Some courts have readily granted orders stopping payments under letters of credit causing unfavourable results internationally. 

"To protect our nation's courts' and banks' international reputation, notice is hereby given as follows: Strictly support the conditions under which the fraud exception to enforcing letters of credit operates. Only where there is ample evidence supporting underlying fraud in the letter of credit transaction and the bank has yet to make payment within a reasonable time may the courts entertain an application from the party opening the letter of credit and upon the provision of security issue a stop payment order.

 "However, if the letter of credit has already been accepted or transferred or remittance made, then no stop payment order may be issued... " (author's translation). 

This direction was certainly welcome and has hopefully put a stop to the more egregious cases but the notice is short on specifics and does not address the practice of "evidence preservation orders" where the courts themselves are boarding vessels and seeking out evidence of apparent fraud. 

If the Chinese courts are going to continue with this practice, it would be hoped that the Supreme Court would issue specific guidelines that would balance the interests involved. 

Ultimately, it will probably take an amendment to the Maritime Procedure Law to prevent the Courts taking action on bare allegations of fraud. So long as the Law remains as it is, the temptation is all too great to seek out freezing orders in less than clear cases. Tread warily. 

The Courts need to exercise great care in not undermining confidence in the documentary credit system on which most international trade relies. If payments under documentary credits are too readily frozen by the Chinese courts, as has happened in recent years, confidence will erode; firm steps need to be taken to ensure this does not happen. 

Shipowners must be extremely wary as claims arising from ante-dated bills of lading will not be covered by their P&I insurers and the risks of claims in China are very high. Ante-dated bills should simply not be issued in any circumstances.

With thanks to Mark Sachs of Thomas Cooper & Stibbard for preparing this article.  

This article was first published in Lloyd's List on 12 May 2004.