Goods worth over $2.2 trillion were imported into the U.S. last year, mainly by sea. While the vast majority were covered by bills of lading
Bills of Lading and Sea Waybills
A bill of lading (a “B/L”) is a document issued by a vessel operator (a “carrier”) to confirm receipt of goods consigned to it for transport and evidence the existence of a contract of carriage. It typically describes the goods, shows the points of origin and destination, sets forth the carriage charges and method of shipment and identifies the person that consigned the goods to the carrier (the “consignor” or “shipper”) and the person that is entitled to claim them when they reach their destination (the “consignee”). It is said to be “clean” if it doesn’t indicate any damage to the containers in which the goods are shipped
A negotiable B/L allows the consignee to transfer the B/L and title to the goods it covers by endorsing and delivering the original to the transferee. If the transferee is a good faith purchaser for value with no notice of any defense against or conflicting claim to the B/L (endorsement and delivery to such a transferee is generally referred to as “due negotiation”), its title to the goods will prevail over almost any interest in the goods asserted by the shipper or anyone whose interest arises after the shipper has entrusted the goods to the carrier. Because title to the goods is “locked-up” in the negotiable B/L, the carrier may only release the goods to the holder of the B/L (properly endorsed to it, if the holder is not the named consignee) and will require the surrender of the B/L as a condition to the release. B/Ls, whether negotiable or nonnegotiable, are “documents of title” for purposes of the Uniform Commercial Code (the “U.C.C.”)
A sea waybill (a “waybill”) looks very much like a B/L and it conveys essentially the same information, but it is designated a sea waybill on its face and it typically incorporates by reference the Uniform Rules for Sea Waybills adopted by the Comite Maritime International (the “CMI Rules”). Like a B/L, it constitutes a receipt for goods consigned for transport and evidence of a contract of carriage, but it authorizes the carrier to release the goods to the consignee upon receipt of proof of identity, without the consignee having to produce the waybill. It may be helpful to think of a waybill not as an authoritative paper document (the carrier does not issue any originals) but as a printout of relevant shipping information from the carrier’s database. Waybills are not bills of lading or documents of title for purposes of the U.C.C. or any international conventions.
Financing Goods Covered
By Negotiable Bills of Lading
In the typical inbound transaction, a U.S. company (the “importer”) purchases goods from an offshore manufacturer (the “seller”, who typically is also the shipper) under a contract that provides for shipment FOB (port of origin)
This structure provides the Bank with robust legal and practical protection. A clean onboard B/L indicates that the goods have been loaded onto the vessel for shipment and the containers appear to be in good condition. A negotiable B/L reduces the risk that the shipper has retained any interest in the goods, transfers control over the goods while in transit to the holder of the B/L
Taking possession of a negotiable B/L also makes it more likely that a U.S. court applying state choice of law principles would find that the Bank’s rights with respect to the underlying goods are governed by applicable state law. As a general rule, the perfection and priority of security interests in a debtor’s assets are governed by the local law of the jurisdiction in which the debtor is located
Most jurisdictions will recognize the person named as consignee on a negotiable document of title as the owner of the goods it covers
- In the example given in the prior paragraph, any legal action by the shipper or one of its creditors to settle conflicting claims to goods located in China will likely be brought in a Chinese court, which would apply Chinese law, including its choice of law principles. Given the relation the transaction bears to China (the location of the seller, the execution and performance of the purchase contract by the seller and, perhaps most importantly, the physical location of the goods), a Chinese court applying local choice of law principles, may well decide that issues regarding the priority of interests in the goods are governed by Chinese substantive law.
- If the trustee in a bankruptcy commenced by the importer under the U.S. Bankruptcy Code moves to avoid the Bank’s security interest in goods that are physically located in China under the strong-arm clause of Section 544(a) of the Bankruptcy Code
13 11 U.S.C. §544(a). 14 See, e.g., In re Michigan Lithographing Co., 997 F. 2d 1158(6th Cir. 1993). 15 See, e.g., In re Lindsay, 59 F.3d 942, 948 (9th Cir. 1995) (a bankruptcy case in which the court found that in federal question cases with exclusive jurisdiction in federal court, such as bankruptcy, the federal, not forum state, choice of law principles apply); but see In re Gaston & Snow, 243 F3d 599(2nd Cir. 2001) (another bankruptcy case, in which the court applied forum state choice of law principles, finding that the dispute did not “implicate significant enough federal interests” to justify doing otherwise).
Financing Goods Covered by Sea Waybills
B/Ls have been the workhorse of international trade for more than 200 years, but as carriers have become more efficient at moving goods around the globe, instances in which the goods reached their destination before the original B/L reached the consignee have become more frequent (particularly when the B/L must first be presented to and processed by the consignee’s lender). The inconvenience of having to track pieces of paper and the costs and delays resulting from storing goods at the dock while documents are located and delivered to the carrier have led to an intensive search for digital alternatives.
Significant efforts have been made to come up with legal structures that would accommodate paperless transactions while providing the parties with the same level of protection as that offered by possession of negotiable B/Ls, and technologies and business practices that would satisfy those legal structures. In the U.S. the efforts have centered on modifications to the U.C.C. (particularly Article 7 and related provisions), which have been adopted in 40 states, and the Uniform Electronic Transactions Act, which has been adopted in 47 states. International efforts have included the CMI Rules for Electronic Bills of Lading, the United Nations Commission on International Trade Law Model Law on Electronic Commerce and the United Nations Convention for the International Carriage of Goods Wholly or Partly by Sea (the “Rotterdam Rules”).
All the drafters have taken essentially the same approach. Desirous to preserve the extensive body of law already developed around paper documents of title, they have generally responded by broadening the definition of “documents of title” to include electronic documents and setting forth the electronic equivalent of concepts such as “original”, “possession”, “execution” and “endorsement”, which are central to determinations of rights to paper documents and the goods they cover
Shipping under waybills has provided a practical and cost-effective solution to the paper problem for shippers, carriers and importers, but the systems employed to generate waybills and keep track of the related shipments do not have the safety features necessary to satisfy the legal structures created to accommodate electronic documents of title. Until they do, secured lenders should continue to insist on negotiable B/Ls for several reasons:
- Diversion Risk. U.C.C. § 7-303(a) protects a secured lender who has taken possession of a negotiable B/L against diversion of the goods by the shipper. Waybills are not bills of lading and accordingly do not allow the secured lender to take advantage of the protections offered by that section.
It should be noted that many international waybills have incorporated the CMI Rules by reference. Section 6 of the CMI Rules provides, among other things, that the shipper is the only party entitled to give the carrier instructions in relation to the contract of carriage and to change the name of the consignee, unless it has exercised its option to transfer control rights to the consignee and the transfer has been noted on the waybill. Secured lenders asked to extend credit against goods covered by waybills must make sure that the shipper exercises this option before funding.
- Risk of Stoppage in Transit. Taking possession of a negotiable B/L cuts off the shipper’s right of stoppage in transit under U.C.C. §2-705. Waybills are not B/Ls and do not provide any protection against the shipper’s right of stoppage. To reduce the risk of stoppage, lenders should consider requiring that the shipper expressly waive that right and that the waiver be noted on the waybill. Requiring such a waiver as a condition of funding is not part of current business practices.
- Perfection and Priority. As noted above, U.C.C. §9-312(c) provides that possession of a negotiable document of title perfects the lender’s security interest in the goods it covers and a security interest so perfected has priority over any conflicting security interest that is perfected by another method. Since a waybill is not a document of title under the U.C.C., the benefit of Section 9-312(c) is not available for collateral consisting of goods covered by a waybill.
18 Perfecting a security interest in such goods requires either the filing of a U.C.C. financing statement (U.C.C. §9-310) or the written acknowledgment of the carrier that it holds possession of the goods for the benefit of the secured lender (U.C.C. §9-313). In light of the alternative methods of perfection, prudence would dictate that the lender do both.
- Choice of Law Principles. As noted above
19 See text accompanying fn. 10 and 11 above. 20 In a nutshell, (a) perfection of a security interest in such goods would be governed either by the local law of the jurisdiction where the debtor is “located” for U.C.C. Article 9 purposes (if the security interest is non-possessory) or the local law of the jurisdiction where the goods are located (if the security interest is possessory) and (b) the priority of a security interest in such goods (and the effect of perfection or nonperfection) would be governed by the local law of the jurisdiction in which the goods are located.
The era of the electronic record is tantalizingly close, but it’s not here yet. Lenders are coming under increasing pressure to accept sea waybills and other transport documents that satisfy the desire of shippers and importers to handle cargo without paper documents, but don’t offer the level of legal protection typically provided by negotiable B/Ls. Lenders who feel that they must accept waybills for competitive reasons would be well advised to require, in addition to all the other things they have traditionally required, (a) evidence that the shipper has exercised its option to transfer control to the consignee under Section 6 of the CMI Rules and has waived its right of stoppage in transit and (b) an acknowledgment from the carrier that it is holding the goods for the benefit of the lender. But the best advice may be to resist the pressure and insist on lending only against good old-fashioned negotiable B/Ls until electronic B/Ls have been judicially tested and have become widely used.