Normally, in international trade or in import and export financing transactions, you would normally hear the words ‘avalisation of a bill of exchange’ or ‘avalisation’. This concept is frequently used in discussions between exporters/importers and its bank’s or financial institution’s officers. This concept, however, is still widely unknown or misunderstood by many banking and financial professionals and legal counsels, hence this short write-up, which we think is relevant and timely.
It is important to note that in Tanzania, there is scarcity of local literature relating to avalisation of a bill of exchange (“a Bill”), and the regulating legislation, that is, the Bills of Exchange Act, Chapter 215, Revised Edition 2002 of the laws of Tanzania (“the Act”) does not offer much insight towards examining this concept, as a result of which, this article attempts to bridge that gap. We shall however see below how for the first time in Tanzania, the High Court (Commercial Division) (“the Court”) was presented with a unique opportunity, yet rare in our courts, to address this concept and its practical application.
What is “avalisation of a Bill”? This denotes an endorsement of a Bill by the drawee’s or payee’s bank with a view of guaranteeing payment if the drawee or payee defaults in honouring a Bill at maturity. An avalisation binds the guarantor (that is the payee’s or drawee’s bank) as a co-obligor of the drawee or payee.
A Bill which is properly avalised by a bank, would substitute a bank’s risk for the importers (buyer) risk, thus providing the exporter (seller) with assurance that payment will be honoured.
Process of Avalising
The process of avalisation normally takes the following steps in Tanzania:
Step 1: The drawer of a Bill will send it to its processing bank together with all underlining importation documentation. Normally at this point, goods have yet to be shipped to the buyer (importer) by the seller (exporter).
It should be noted that it is not the duty of a bank or financial institution receiving the importation documentation to validate or scrutinize the documentation, thus, both parties to the sale transaction must ensure the genuineness and validity of all the underlining documentation.
Step 2: The processing bank will send the importation documentation to the drawee’s or debtor’s bank with instructions to only release the documents once a Bill has been accepted by the drawee or debtor and avalised by its bank.
Step 3: On receiving the documents, the drawee’s or debtor’s bank will then notify and send that Bill to its client (the drawee) with instruction to accept the Bill and authorise them (the bank) to avalise it.
Step 4: The drawee or debtor after receiving the notification from its bank, will accept that Bill by signing (by authorised officers) and stamping it with its company’s stamp or seal.
Step 5: Once the drawee or debtor has signed and stamped that Bill, its bank will endorse (avalise) its guarantee and record a liability against the debtor, which will subsist until that Bill matures and is fully satisfied.
Cost of Avalising
A bank or financial institution would normally impose a service fee for avalising a Bill, as this is a normal service given by banking or financial institutions to its customers like a letter of credit. The rates applicable differ from one commercial bank or financial institution to the other. When issued, an avalisation constitutes a direct payment obligation by a bank or financial institution and it needs to treat it with maximum capital provisioning per Basel III rules.
Security Status
An avalisation is a guarantee of payment for the duration of a Bill following acceptance by the debtor and avalised by its bank. Hence, there is/are similarity(ies) between the level of security offered by an avalised Bill and that of a letter of credit, that is, they both guarantee payment by the debtor’s or importer’s bank.
Landmark Decision
The Court discussed the concept of avalisation in a landmark judgement between the National Bank of Commerce Limited (Plaintiff) versus Tancoal Energy Limited (Defendant), Commercial Case No. 39 of 2016 before Hon. Mwandambo J. (as he then was). As far as we are aware, this is currently the only case that addresses the concept of avalisation.
The facts of the case were that, the Defendant instructed the Plaintiff to submit certain documents to Standard Chartered Bank of Uganda (SCBU) for delivery to a company in Uganda known as Steel Rolling Mills Limited (SRML) to whom the Defendant had supplied coal worth USD469,894.50. The Defendant issued a Bill dated 24 October 2013 for the value amount of the supplied coal payable after 120 days, which the drawer was SRML.
Earlier on the Defendant had requested the Plaintiff to request SCBU to avalise the Bill, which entailed the said bank making and undertaking to pay the Bill thereby making it easier to discount it. All the same, the Plaintiff acceded to the Defendant’s request for the discount of the Bill at 100% at an interest rate of 8% plus discounting commission of USD500. By discounting the Bill, the Plaintiff agreed to pay, and it paid the Defendant the amount of the Bill prior to the expiry of 120 days during which the drawee was to pay the same in consideration of the discounting interest and the relevant commission. That meant the proceeds of the Bill were now to be paid to the Plaintiff upon expiry of 120 days in lieu of the Defendant. By doing so, the Plaintiff stepped into the shoes of the Defendant with entitlement to benefit from the amount stated in the said Bill.
However, for reasons not apparent on the record, and despite several reminders from the Defendant and SCBU, the Plaintiff did not communicate the request to SCBU to avalise the Bill, as a result, the Bill was dishonored upon maturity, and the Plaintiff did not receive any payments therefrom. Thus, the Plaintiff instituted the suit for payment of a sum of money arising from a dishonored Bill plus interest and costs. Several issues were framed by the Court, among others, one for purposes of this article was whether the Plaintiff had a duty to avalise the Bill as requested by the Defendant?
In response to this issue, the Court held inter alia that, the Defendant’s request for Bill avalisation by SCBU was not a simple request to be acted upon or ignored at the Plaintiff’s whims, rather instructions by a customer to its bank meant to mitigate against the potential risk from non-payment of the Bill amount as it turned to be the case. In addition, despite the use of the word avalisation, the request from the Defendant was not a simple one nor was it from a stranger, but constituted instructions from a customer to its banker which had to be acted upon as it was in the Plaintiff’s interest to have the Bill avalised, and this was made very clear to it in the correspondence proceeding the remittance letter to SCBU. It that regard, the Court concluded that, the Plaintiff was not entitled to recover the Bill amount from the Defendant. The Plaintiff lost this issue, and altogether the suit.
Lastly, it is worth re-emphasizing that avalisation is an important denominator in international trade or in import and export financing transactions which utilizes a Bill, hence banking and financial professionals in Tanzania must always be mindful of this requirement, otherwise it becomes invalid and of no value, leaving banks and financial institutions financially and legally exposed like in the case discussed above.
Note: This is not a legal opinion and the contents hereof are not meant to be relied upon by any recipient unless our written consent is sought and explicitly obtained in writing.
