1. What is a Documentary Credit?

A documentary credit is an irrevocable undertaking of the Issuing Bank to pay the beneficiary if it presents complying documents on their face, irrespective of the underlying sale contract. This is the Autonomy Principle.

Banks deal in documents, not in goods.

2. What is Payment "Under Reserve"?

When documents are presented and the bank finds discrepancies from the terms of the LC, it has two options under UCP 600 Article 16:

a) Refuse to honour, OR
b) Approach the applicant for waiver and / or Pay/Honour Under Reserve

"Under Reserve" means:

The bank pays / negotiates / accepts the documents subject to a reservation of right that if the applicant / issuing bank does not accept the waiver of discrepancies, the bank can reclaim the money from the presenter.

It is essentially a payment with recourse backed by an indemnity.

There are two common forms:

1. Nominated / Negotiating Bank presenting Under Reserve to Issuing Bank:
The negotiating bank says: "Documents have discrepancies X, Y. We have paid the beneficiary under reserve. Please remit to us under reserve. If you don't get applicant's approval, we will refund you."

2. Issuing Bank paying Under Reserve to Beneficiary/Negotiating Bank:
Issuing bank says to applicant: "Discrepancies exist, but we will release documents and pay under reserve, subject to your approval. If you reject, you must return documents and goods remain bank's security."

The Covering Letter typically says: "We have negotiated documents with discrepancies as detailed below under reserve for your approval..."

Under UCP 600 Article 16(c)(iii)(b), if issuing bank decides to refuse, it must state:

• It is refusing
• List EACH discrepancy
• What it is doing with documents - (a) holding for presenter, (b) returning, etc.

If it fails to give a valid refusal notice within 5 banking days, it is precluded from claiming discrepancies - Article 16(f). Therefore, banks often use "under reserve" to avoid preclusion while still seeking waiver.

3. Legal Nature

1. Not a Complying Presentation: A presentation under reserve is by definition a non-complying presentation.
2. Conditional Payment: It converts an irrevocable payment into a conditional one. The beneficiary gives an indemnity.
3. Recourse Available: Unlike a true negotiation of a complying presentation which is without recourse to beneficiary, payment under reserve is WITH recourse.
4. Risk Shift: Risk remains with the negotiating bank / beneficiary until waiver is obtained.

4. Detailed Case Laws

A. Indian Leading Authority - Reserve Mechanism

1. United Commercial Bank v. Bank of India & Ors. (1981) 2 SCC 766 [SC of India]

This is the locus classicus on reserve in India.

Facts: Vinmar Impex Singapore was seller of HDPE powder. UCO Bank issued irrevocable LC. Bank of India was negotiating bank. Documents had some discrepancies. Bank of India negotiated and claimed payment from UCO Bank under reserve. UCO Bank paid initially under reserve but later sought to recall the money alleging discrepancies and fraud.

Held by Supreme Court:

• An irrevocable LC creates absolute obligation on issuing bank to pay against documents which appear on face to be in accordance with LC terms.
• The negotiating bank acting on behalf of beneficiary, when it has paid under reserve, does so on the basis of an indemnity from beneficiary. Issuing bank cannot unilaterally impose "under reserve" condition to avoid payment if documents are in fact complying.
• Once issuing bank has paid under reserve without proper refusal notice under UCP, it cannot recall the money from negotiating bank on ground of alleged discrepancies.
• Court restrained issuing bank from recalling amount paid under reserve, holding it would destroy confidence in banking system.

Principle: Payment under reserve protects negotiating bank, but cannot be used by issuing bank as a device to escape liability for a complying presentation.

2. Tarapore & Co. v. V/O Tractoroexport, Moscow (1969) SC
Established that autonomy of LC cannot be interfered with except in case of clear fraud to knowledge of bank.

B. English / International Authorities

3. Fortis Bank SA/NV and Stemcor UK Ltd v. Indian Overseas Bank EWCA Civ 58 - On UCP 600 Article 7(c)[2011]

Facts: IOB issued LC subject to UCP 600 requiring full set of original clean on-board Bills of Lading. Charter party bills were presented. IOB refused. Confirming Bank Fortis had negotiated under reserve.

Held: Court of Appeal clarified UCP 600 Article 7(c) and Article 8.

• Issuing Bank undertakes to reimburse a nominated bank that has honoured or negotiated a complying presentation.
• If presentation is non-complying and nominated bank negotiates under reserve, it does so at its own risk. It is NOT entitled to reimbursement unless issuing bank waives discrepancies.
• This case defines the limit of reserve: No waiver = No reimbursement.

This is the most cited case on confirming banks and nominated banks under UCP 600.

4. Banco Santander SA v. Banque Paribas 1 All ER (Comm) 776[2000]

Facts: Santander confirmed LC issued by Paribas, negotiated discrepant documents under reserve. Applicant refused waiver. Santander sought reimbursement from Paribas.

Held: Court held Paribas was liable to reimburse Santander because Santander had negotiated documents that were apparently complying and had reserved its rights correctly. The negotiation under reserve did not destroy the confirmation, but it converted it into a claim under indemnity. This case is always taught with reserve banking - a confirming bank that pays under reserve can still claim if it acted in good faith.

5. Hamzeh Malas & Sons v. British Imex Industries Ltd 2 QB 127[1958]

Lord Jenkins stated the fundamental rule that buyer cannot instruct issuing bank to withhold payment once complying documents are presented. Reserve cannot be imposed unilaterally after presentation to defeat beneficiary's right.

6. Seaconsar Far East Ltd v. Bank Markazi Jomhouri Islami Iran 1 Lloyd's Rep 36[1999]

House of Lords: Exception to autonomy is only fraud. A mere allegation of discrepancy does not allow issuing bank to refuse; if it wants to rely on discrepancy it must give proper refusal notice. If it instead pays under reserve, it is deemed to have taken up documents subject to applicant's approval.

7. Credit Agricole Indosuez v. Muslim Commercial Bank Ltd 1 All ER 706 (Privy Council)[2000]

Held: When issuing bank gives notice of refusal under UCP 500 Article 14 (now Article 16 UCP 600), it must give single notice listing all discrepancies. If it fails to list a discrepancy then, it is precluded from raising it later. Banks use reserve precisely to avoid this preclusion trap - by not refusing outright but seeking waiver under reserve.

5. Present Procedure as per ICC Opinions

Under ICC DOCDEX 352 and TA opinions:

1. Negotiating bank must clearly state discrepancies for which reserve is made.
2. Must obtain beneficiary's indemnity letter: "We will refund with interest if reimbursement not received."
3. Issuing bank has 5 banking days to decide. It cannot send conditional refusal - refusal must be unconditional.
4. If applicant waives, issuing bank must honour without recourse.
5. If applicant rejects, issuing bank must return documents and can claim refund from negotiating bank.

If issuing bank fails to act per Article 16(c), it loses right to claim discrepancy and must pay even if paid earlier under reserve.

6. Summary Distinction Table