HB 79 - UNIFORM COMMERCIAL CODE:LETTERS OF CREDIT Number 0005 CHAIRMAN ROKEBERG announced the committee's next order of business would be HB 79, "An Act relating to letters of credit under the Uniform Commercial Code; and providing for an effective date." He stated the committee would continue the public hearing. He invited Jerry Weaver forward. JERRY WEAVER, Senior Vice President and Manager of Commercial Lending, National Bank of Alaska (NBA); Secretary-Treasurer, Alaska Bankers Association, came forward testify in strong support of HB 79 on behalf of both organizations. He indicated Mr. Art Peterson, Alaska Uniform Law Commissioner, is much more knowledgeable regarding the Uniform Commercial Code (UCC). Mr. Weaver indicated the legislation is part of the regular UCC revisions which is an ongoing process of the full commercial and consumer code through the National Conference of Commissioners on Uniform State Laws (NCCUSL), as Mr. Peterson will testify. These revisions and this legislation affects a rather arcane group of letters of credit, a small area of commercial law. Mr. Weaver noted there is another well-known version called the "stand-by letter of credit." The negotiable letters of credit primarily affect international trade. Mr. Weaver indicated these negotiable letters of credit are guarantees, usually by banks to banks or large commercial companies with rated credits. These institutions can substitute their credit for a small firm either unknown in the international market or without the credit rating necessary to carry out the transaction. These letters of credit are typically issued by banks, usually through their international banking departments; the process is done bank to bank. In Alaska, a letter of credit is needed in any of the export and many of the import (indisc.) to guarantee that payment will be forthcoming and to ensure that supplier's details are met. Mr. Weaver said his knowledge concerns the practical side; he does not deal with the close technical parts but he indicated NBA has personnel who do. Mr. Weaver mentioned several other banks had reviewed the legislation in detail and approved it. He indicated the bill has been worked on for an extended period of time. Number 0118 MR. WEAVER gave the example of shipping lumber from Southeast Alaska to a large firm in Tokyo, Japan, that wishes to buy this lumber but ensure it receives exactly what it buys by grade, quantity, et cetera, and ensure that the lumber is on the ship. The firm goes to its bank - in this example the Industrial Bank of Japan, Limited - to have the bank issue a letter of credit. While the Japanese firm may or may not be known to the Southeast Alaska timber supplier, the Industrial Bank of Japan, issuing a letter to NBA, certainly is known because it is rated. What this credit rating immediately says to the Southeast firm is that if it delivers the lumber, it will be paid. Number 0163 MR. WEAVER noted the letter of credit will primarily deal in documents. The bankers will never see the timber but they will see the documents stating it is there. The letter of credit and this legislation speak about some of the documents that might or might not be included: 1) a bill of lading showing the lumber got on the ship, the shipping documents, an individual authorization issued by the shipping company. He indicated these were the documents that allow one to get the lumber off the ship when it reaches Japan as well. 2) Some form of grading and rating of the lumber by an authority independent of the transaction that states it put so many thousand board feet of such and such grade and type on that ship. 3) Some insurance documents in case of loss at sea. The letter of credit issued by the Industrial Bank of Japan would say that if those documents are sent and are in proper order, it will pay on those documents. At this point the ship is underway and the buyer's bank would extend credit to the buyer for some short period of time through whatever credit lines, et cetera, that had been set up. Number 0220 MR. WEAVER referred to some discussion at the previous hearing regarding time delays. He noted "float" and similar things were not issues because money had not been exchanged in this transaction; they are simply speaking of guarantees. Mr. Weaver commented the other side is time for delays. In a large commercial project such as this, there will typically be minor discrepancies in the contract. "'Gee, we don't have as much hemlock as these guys want, is it okay if we send them spruce?'" The bank needs time to wire the other bank and ask whether a substitution is acceptable. Another issue could be a dramatic price change in the commodity with the seller requesting a possible small change in price. Those wires go back and forth between the two banks' international banking departments, they agree on firm detail, and then the transaction is concluded. The material is on its way, the letter of credit is presented for payment, that bank wires funds to the seller's bank who in turn credits its customer. Mr. Weaver indicated that described the practical workings of these letters of credit. CHAIRMAN ROKEBERG stated he thinks Mr. Weaver's description helps explain the practical application of the legislation on a fundamental basis. Number 0282 REPRESENTATIVE MURKOWSKI agreed Mr. Weaver's description was very well-put. She commented that NBA issued the letter of credit for a fee. MR. WEAVER agreed that is correct when NBA is issuing one. In his example, the Industrial Bank of Japan, as the issuer, would receive the initial fee. There would be also be some small fees on the other bank's side assessed for handling. REPRESENTATIVE MURKOWSKI said she asked because she noticed consideration is not required in the legislation. She questioned why this requirement had been deleted, noting she had always assumed fees were a part of letters of credit. Number 0317 MR. WEAVER answered that cases where fees were not drawn had come up somewhere in the revision. He indicated sometimes the size of the parties involved might determine this, commenting that a company like Exxon Corporation could probably negotiate its way out of a fee. This allows that room. Mr. Weaver indicated HB 79 is simply the revision of a 30-year old law that works very, very well. This somewhat arcane thing affects about 5 percent of the banking business and, for the most part, the UCC revisions are just refinements. The UCC commissioners asked the bankers worldwide who deal in these for suggestions. He confirmed to Representative Murkowski, however, that in most cases there is a fee. REPRESENTATIVE HALCRO referred to the initial bill hearing on February 26, 1999, and asked if the seven day time period for denial is adequate for letters of credit. MR. WEAVER responded he doesn't deal with letters of credit daily, but the international bankers and specialists present last week say it is adequate. He noted NBA has numerous customers in Alaska that use this as a vehicle and it seems to work well. Number 0440 ART PETERSON, Alaska Uniform Law Commissioner, National Conference of Commissioners on Uniform State Laws, came forward to testify. Mr. Peterson stated he was an attorney in private practice with the law firm Dillon and Findley, P.C., in Juneau, and was present in his capacity as a uniform law commissioner for the state. He commented on Mr. Weaver's excellent capsule description of how letters of credit are used. Noting it has been 40 years since this was originally drafted, Mr. Peterson commented a number of issues have arisen since then and a number of technologic developments have occurred. The legislation is mainly aimed at: 1) addressing and solving issues that have arisen, and avoiding litigation; 2) recognizing the existence of computers. He exhorted the committee to also keep in mind that although letters of credit may be a small part of this entire commercial area, it is a $200 billion a year industry. Half of exports from the United States are financed by letters of credit. Number 0525 MR. PETERSON stated the UCC, including Article 5, has been adopted in all 50 states, the District of Columbia, Guam, Puerto Rico, et cetera. It serves as something of an international model; in practice it somewhat governs many transactions. A corresponding body of material has developed in the area of letters of credit, the Uniform Customs and Practices for Documentary Credits (UCP 500) promulgated by the International Chamber of Commerce. Mr. Peterson indicated in response to the chairman's question that the uniform law had been revised from the previous year. Mr. Peterson stated approximately 30 states had enacted this, including Illinois and California, two of the major financial centers. He explained New York usually lags a year or so behind on UCC enactments and revisions because of an elaborate procedure with the bar. For the chairman, Mr. Peterson said that Washington, Idaho, California, Hawaii, et cetera, have already adopted this. MR. PETERSON indicated this legislation recognizes the UCP 500 and also specifically recognizes international customs and practices that have developed over the years outside of that formal material. The bill recognizes that various entities involved in letters of credit are in positions to negotiate to avoid fees. He has not heard anything to suggest the lack of consideration would be a problem. Mr. Peterson offered to make the formal published UCC revision with the official commentary by the NCCUSL available to the committee. Mr. Peterson indicated the revisions anticipate a number of problems, solve a number of old issues and generally update the approximately 40-year old law; it is necessary for Alaska to keep up-to-date. Number 0760 CHAIRMAN ROKEBERG asked for an citation within the bill which could be used as an example of a needed update. MR. PETERSON referred to the UCP 500. The use of computers has been recognized in those customs and practices. CHAIRMAN ROKEBERG asked if those were being adopted by reference or if the concepts were basically embodied. MR. PETERSON replied it was essentially adopting by reference. The material he provided to the committee notes that UCC Article 5 recognizes the UCP 500, which is used in most international letters of credit, providing operational rules and standards that have international acceptance. They could not have that international acceptance unless they were recognizing modern practices and technology. CHAIRMAN ROKEBERG asked if the UCP 500 was periodically revised via additions. MR. PETERSON indicated it might be contained in the commentary from the NCCUSL, but said he hadn't reviewed that material in a long time. Number 0863 CHAIRMAN ROKEBERG referred to the "Northern Lights case et al," stating adopting things by reference becomes problematic in Alaska statutory construction. He asked Mr. Peterson for further information regarding that question. MR. PETERSON said wording to the effect of "is hereby adopted by reference" now had to be used. CHAIRMAN ROKEBERG noted, "The problem is we have a supreme court case (indisc.) the UBC (ph) as it relates to adoption by reference." Chairman Rokeberg commented he thought one way to get around that was adoption by reference of a dated addition because that, therefore, is then revised. Number 0914 MR. PETERSON stated that has long been the rule in the regulations. Any adoption in the regulations had to be by specific edition with the adopting agency named, and, at least in the footnote, information provided on where it can be obtained. The statutes have been somewhat looser. When the state had an income tax, it adopted the federal income tax by reference. However, every time the federal law was amended it did not have to be updated in the Alaska Statutes. CHAIRMAN ROKEBERG referred to the "OSG case" [State of Alaska v. OSG Bulk Ships, Inc.] the previous year which was about adopting parts of the United States tax code. The chairman noted there is a lot of precedent in the statutes to withhold that; it is an issue that would probably come up in the House Judiciary Standing Committee. The chairman referred to the sectional analysis, page 9, of Section 18, Sec. 45.05.116(c), [Theresa Bannister, Legislative Counsel, 2/17/99]. This portion of the sectional analysis reads: "AS 45.05.116(c). States that, except as provided otherwise in this subsection, the liability of certain listed persons is governed by rules of custom or practice that the parties expressly select for the letter of credit or confirmation, or undertaking. Gives as an example the Uniform Customs and Practices for Documentary Credits. States that if both this chapter and the rules of custom or practice apply to the liability, the rules govern, unless they conflict with a provision of this chapter that cannot be changed (see AS 45.05.103(c))." CHAIRMAN ROKEBERG commented it appears there would be an agreement within the credit documents to be bound by those, unless overcome by superior statutory right. MR. PETERSON agreed, noting the default position is stated and the parties can overcome that by their agreement. Number 1055 REPRESENTATIVE MURKOWSKI referred to the mention of standard practice in Section 10, page 7, indicating she did not see how standard practice was incorporated into the text of the statute because subsection (e) says that it will be determined by court. She questioned how one knows what the standard of practice is, wondering whether it was possibly the UCP 500 - a separate document known within the industry. MR. PETERSON said, "I've never seen it myself, but it is a substantial body of material." REPRESENTATIVE MURKOWSKI commented, "But it is something that someone can refer to -- look at it and say, 'Ah, that's what it is.'" She confirmed Mr. Peterson agreed. Representative Murkowski asked if this legislation is the same language received from the "National Commission on Uniform Code" or if it was adapted for Alaska. Number 1140 MR. PETERSON said it adheres very closely to the official version, with minor stylistic changes made by the Legislative Affairs Agency, and there should not be any substantive change. REPRESENTATIVE MURKOWSKI noted she had some technical questions -like could one waive being an adviser? - she felt comfortable not addressing if Mr. Peterson could assure her that Alaska's law would be consistent with the recommendations of the national commissioners and what had been accepted in 38 other states. MR. PETERSON assured her this was correct. He did not know what changes other states might have made, but he is not aware of any particular issue causing some states to opt in one direction and other states to opt differently. In some uniform acts produced by the national conference a provision a state could accept or reject is placed in brackets. Mr. Peterson did not offhand recall any such options, especially any of major importance, in this. Number 1288 CHAIRMAN ROKEBERG suggested Representative Murkowski contact Mr. Peterson for the answers she desired before the legislation is heard in the House Judiciary Committee. REPRESENTATIVE HALCRO asked for clarification on page 2, lines 20 through 22, "... the applicant may recover damages resulting from the breach, including incidental but not consequential damages, less any amount saved as a result of the breach." Number 1357 MR. PETERSON replied they were speaking of a dollar amount transaction. In the example of lumber sold to a Japanese buyer who had the bank issue the letter of credit, if that applicant had planned to sell the lumber to another party but lost the benefit of that contract, that would be consequential damages and are avoided by this provision. Incidental damages might be the applicant's expenses involved in shipping the product over there; those would be incidental to the basic transaction and it could collect that somehow if the deal went wrong. Thirdly, he addressed the language, "less any amount saved as a result of the breach". If, for example, the price has gone wrong and therefore the applicant has saved money by the failure of this contract, or hasn't lost the full dollar value of the original contract, that would be subtracted from any damages the applicant could recover. CHAIRMAN ROKEBERG noted this could be currency fluctuations and he would also suspect it to be a duty of mitigation. He asked if there isn't normally a duty to mitigate. MR. PETERSON said that assuming there is the possibility to mitigate or one makes reasonable efforts. CHAIRMAN ROKEBERG said, "Right, and (indisc.) brokering or the cost of securing a new buyer (indisc.) product. MR. PETERSON answered probably. Number 1490 REPRESENTATIVE MURKOWSKI noted she thought there was no duty to mitigate, but if you did then you could... MR. PETERSON note he did not remember the no duty to mitigate provision, questioning if it is in the same section, Sec. 45.05.111. CHAIRMAN ROKEBERG commented he thought there would be a duty to mitigate. Number 1530 REPRESENTATIVE MURKOWSKI noted Section 13, lines 12 through 16, which read: Sec. 45.05.111. Remedies. (a) ... The claimant is not obligated to take action to avoid damages that might be due from the issuer under this subsection. If, although not obligated to do so, the claimant avoids damages, the claimant's recovery from the issuer is reduced by the amount of damages avoided. The issuer has the burden of proving the amount of damages avoided. ... MR. PETERSON stated he believed there is discussion of that provision in the official commentary he has provided. Number 1598 CHAIRMAN ROKEBERG indicated the legislation had had a thorough hearing the previous session. Chairman Rokeberg confirmed there were no further questions for Mr. Peterson. He asked Mr. Peterson to give the chairman's regards to Mr. Kurtz, and thanked them both for their work on behalf of the state as uniform law commissioners. Confirming no one else wished to testify, he stated the public hearing on HB 79 is closed. Number 1715 REPRESENTATIVE HALCRO made a motion to move HB 79 out of committee with the attached zero fiscal note and individual recommendations. There being no objection, HB 79 moved out of the House Labor and Commerce Standing Committee.