documentary credits in theory and practice

UNIVERSITA’ UMANESIMO LATINO S.P.A.

NEW EUROPE MASTER IN BANKING AND

ENTREPRENEURSHIP – IV Edition

“Documentary Credits in theory and practice”

SUPERVISORS: STUDENT:

Prof. Matej Lah Igor Vitomir

Fulvio Zampieri

ACADEMIC YEAR 2006 – 2007

C O N T E N T S

1. DEFINITON OF THE DOCUMENTARY CREDIT..........................................3

1.1. Definition..........................................................................................................31.2. Historical development...................................................................................31.3. How the documentary credit works?.............................................................4

1.3.1. Cycle 1 - The documentary credit.............................................................41.3.2. Cycle 2 - Shipment of goods.....................................................................61.3.3. Cycle 3 - Presentation and honouring of documents.................................61.3.4. Cycle 4 – Customs and clearance of the goods.........................................6

1.4. Why use a Letter of Credit?...........................................................................62. TYPES OF DOCUMENTARY CREDITS...........................................................8

2.1. Sight or term/usance documentary credits...................................................82.2. Revocable or irrevocable documentary credits............................................82.3. Unconfirmed or confirmed documentary credits.........................................92.4. Documentary credits available by payment and by negotiation...............102.5. Special types of a documentary credit.........................................................12

2.5.1. Red clause documentary credit................................................................132.5.2. Green clause documentary credit............................................................142.5.3. Transferable documentary credit.............................................................142.5.4. Back to back documentary credit............................................................162.5.5. Deferred payment documentary credit....................................................16

2.6. Other types of documentary credits............................................................172.6.1. Standby letters of credit...........................................................................17

3. BENEFITS OF A LETTER OF CREDIT...........................................................19

3.1. Benefits for the Exporter/Seller...................................................................193.2. Benefits for the Importer/Buyer...................................................................193.3. Disadvantages of the documentary credits..................................................203.4. Risks in using documentary credits.............................................................21

4. GOVERNING LAW AND RULES FOR DOCUMENTARY CREDITS........22

4.1. Uniform Customs and Practice for Documentary Credits (UCP)............224.2. General Principles of UCP............................................................................234.3. Legislation and documentary credits...........................................................234.4. Basis for opening a documentary credit......................................................24

5. THE ISSUANCE OF DOCUMENTARY CREDIT...........................................28

5.1. Issuance and handling by the issuing bank.................................................285.2. Liability of the issuing bank.........................................................................295.3. Contents of the documentary credit............................................................295.4. Advising the letter of credit and obligation of the advising bank.............315.5. Amendments of the documentary credit.....................................................32

1

6. MAJOR STEPS IN AN IMPORT/NOSTRO AND EXPORT/LORO

DOCUMENTARY CREDIT TRANSACTION..........................................................35

6.1. Import/nostro letter of credit.......................................................................356.2. Export/loro letter of credit............................................................................36

7. DOCUMENTS USUALLY REQUIRED UNDER A LETTER OF CREDIT.38

7.1. Draft (bill of exchange or tenor bill)............................................................397.2. Commercial Invoice.......................................................................................407.3. Consular or Customs Invoice.......................................................................417.4. Transport documents....................................................................................41

7.4.1. Bill of Lading..........................................................................................427.4.2. Air Waybill..............................................................................................477.4.3. Rail consignment note (CIM)..................................................................487.4.4. Road consignment note (CMR)...............................................................497.4.5. Inland waterway transport document......................................................507.4.6. Freight forwarder’s certificate.................................................................517.4.7. Post and courier receipts..........................................................................51

7.5. Other documents...........................................................................................517.5.1. Insurance Policy or Certificate................................................................517.5.2. Certificate of Origin................................................................................537.5.3. GSP certificate (GSP: Generalized System of Preferences)....................537.5.4. Movement certificate (EUR)...................................................................537.5.5. Import and export licenses.......................................................................547.5.6. Health or phyto-sanitary certificate.........................................................547.5.7. Inspection Certificate...............................................................................547.5.8. Packing List.............................................................................................547.5.9. Quality certificate....................................................................................557.5.10. Warranty..................................................................................................557.5.11. Shipping company’s declaration.............................................................55

8. PRESENTATION OF DOCUMENTS................................................................56

8.1. Honouring documents under documentary credit.....................................568.2. Examination of documents...........................................................................568.3. Discrepancies in the presented documents..................................................588.4. Refusal of documents....................................................................................598.5. Guidelines for dishonouring the documents...............................................61

9. SOLVING DISPUTES AND FRAUDS IN DOCUMENTARY BUSINESS....62

9.1. Courts decisions, arbitration and expert decisions....................................629.2. Fraud and forgery.........................................................................................62

10. A BRIEF EXPLANATION OF TRADE TERMS..........................................64

11. PARTIES INVOLVED IN A DOCUMENTARY CREDIT

TRANSACTION............................................................................................................65

LITERATURE AND SOURCES:...................................................................................67

2

1. DEFINITON OF THE DOCUMENTARY CREDIT

1.1. Definition

In simple terms, a letter of credit is a bank undertaking of payment separate from the

sales or other contracts on which it is based. It is a way of reducing the payment risks

associated with the movement of goods, especially in international trade.

Expressed more fully, it is a written undertaking by a bank (issuing bank) given to the

seller (beneficiary) at the request, and in accordance with the buyer's (applicant)

instructions to effect payment — that is by making a payment, or by accepting or

negotiating bills of exchange (drafts) — up to a stated amount, against stipulated

documents and within a prescribed time limit. Maybe one of the best definitions is

provided in Article 2 of the ICC (International Chamber of Commerce in Paris) rules of

the Uniform Customs and Practice for Documentary Credits, Publication No. 500 (the

UCP 500) which says: “A documentary credit is an arrangement whereby a bank that

acts according to instructions received from a customer (the applicant) commits itself to

pay an amount to a third party (the beneficiary) against that party’s presentation of

stipulated documents complying with the credit.”1 As we can see from this definition, a

documentary credit is an instrument that provides:

• a guarantee that payment to the beneficiary is to be effected,

• arranges that payment

• ensures that agreed term of payment is applied

As it can be seen basic functions of a documentary credit (letter of credit) are guarantee

and instrument of payment, but it can be also used as a means of finance. When the

documentary credit has been issued, payment is conditional upon the presentation of

complying documents. Once these documents have been presented and approved, a

bank’s payment undertaking has been established. The documentary credit can also be

used as security for any other transaction in the same way as a traditional bank

guarantee. Such a documentary credit is called stand-by letter of credit.

1.2. Historical development

Trading as an activity arose at a very early stage in the development of the different

societies. At first it took a form of barter or exchanging goods for goods. Later, money

1 Article 2 of the ICC (International Chamber of Commerce in Paris) rules of the Uniform Customs and Practice for Documentary Credits, Publication No. 500 (the UCP 500)

3

as a mean of exchange was invented to improve trade. With the invention of money and

different means of transport it became possible to trade with countries from all over the

world. As the societies became more developed and civilized, trade was arranged

among people in a much more professional way. If the buyer was unknown at the

seller’s place, it could be hard to effect the trade and in that manner such a buyer turned

to well-known commercial house in that market to accept his bill of exchange. Some of

these commercial houses evolved into acceptance houses or confirming houses or what

is known today as merchant banks.

It is believed that the documentary credit emerged in the late 18 th century. In fact

it took the same shape, as we know it today, while the governing rules became more

detailed over time. The documentary credit is primarily used in the international trade

although sometimes it is used within one country that is usually of vast size. As it has a

function of a guarantee it is often used in times of political unrest, especially when wars

are threatening to destroy normal trade relations between some countries. It was also

believed that after World War II the use of documentary credits would decrease, but this

assumption was wrong. The number of documentary credits issued decreased only a

little, while turnover in terms of value has risen significantly. However, turnover

relative to global trade turnover is declining.

1.3. How the documentary credit works?

The documentary credit can be shown as a process that is functioning in 4 cycles. These

cycles can be named as:

1) The documentary credit

2) Shipment of goods

3) Presentation and honouring the documents

4) Customs clearance of the goods

In practice all of these cycles can be overlapped by each other and not necessarily

divided.

1.3.1. Cycle 1 - The documentary credit

It starts with agreement between the buyer and the seller. It is the buyer who arranges

for the credit to be issued. The buyer has to fill in application form based on the written

trade agreement and submit this form to his bank. The bank will, of course, evaluate the

client’s creditworthiness following its procedure and decide whether to issue or not the

4

documentary credit in favor of the client/applicant. The letter of credit is a type of

placement where the exposure to risk lasts till the payment is being made by the

applicant i.e. till the maturity date for payment (usually not over 360 days). The bank

usually defines application form and it is made in such way to eliminate possible

misunderstandings. The application form must contain all the information required for

the bank to issue the credit, as the bank does not know the contents of the agreement.

The buyer should know that a documentary credit is binding when issued, not only for

the issuing bank but also for the buyer, and it can be amended only with the consent of

the seller.

Having checked the buyer’s application and clarified any questions of doubt, the

bank will issue the documentary credit and send it to its correspondent bank at the

seller’s place. If the buyer states a specific bank through which the credit is to be

advised, the issuing bank will use that bank if possible. The documentary credit is now

usually transmitted electronically by teletransmission, although it is still possible to

send it by post office or different couriers in paper form. Today banks use SWIFT

network2 regarding all necessary actions under documentary credits. Usually the issuing

bank (buyer’s bank) will send electronically the letter of credit directly to the

beneficiary’s bank (seller’s bank). If those two banks do not have SWIFT electronic

keys exchanged, then the letter of credit is transmitted to one of the correspondent banks

of the issuing bank, which then finds the shortest way to send the documentary credit to

the beneficiary bank.

The advising bank, after making sure that documentary credit is genuine or

appears to be genuine, will then advise the seller (the beneficiary) of the issuance of the

credit by transmitting it to the seller. The credit will be advised with or without

confirmation of the advising bank. Confirmation of the advising bank means its liability

to pay the funds denoted in that particular documentary credit, even in case of failure of

the buyer or issuing bank. Advising bank has no commitments in this regard in case of

transmitting the credit without adding its confirmation. The seller should examine the

received letter of credit to see if it is in accordance with the sales contract or any other

agreed terms and conditions. If the seller will not accept the credit, he must ask the

buyer to amend the terms and conditions of the credit.

2 www.swift.com – S.W.I.F.T. (Society for Worldwide Interbank Financial Telecommunication)

5

http://www.swift.com/

1.3.2. Cycle 2 - Shipment of goods

After receiving letter of credit, which by his opinion is in order and all conditions are

met, the seller (the beneficiary of the letter of credit) will arrange the shipment of goods.

When the goods have been shipped, the seller will receive the transport document from

the carrier and arrange for the issuance of all the other documents stipulated in the

credit.

1.3.3. Cycle 3 - Presentation and honouring of documents

After the shipment of the goods seller should have all the stipulated documents in its

possession and should present them to the nominated bank. When the bank has

examined the documents it will usually, depending on the relevant credit, effect the

payment to the beneficiary. The nominated bank will after that, transmit the documents

to the issuing bank in order to receive payment. The issuing bank will also examine the

documents to ensure that the terms and conditions of the documentary credit have been

fulfilled. Then the issuing bank will reimburse the nominated bank in accordance with

received payment instructions from the nominated bank. If the buyer agrees to approve

the documents as conforming or if the documents meet all stipulated conditions, the

issuing bank will send the documents to the buyer (the applicant). At the same time the

issuing bank will demand payment from the buyer (the applicant).

1.3.4. Cycle 4 – Customs and clearance of the goods

It often happens that the buyer needs some of the stipulated documents required under

the credit to get access to the goods and to have them cleared through the customs. He

will specifically need the documents giving the title or ownership over the goods (some

transport documents such as bill of lading) and those needed for customs or ones needed

to pay lower custom tariffs. When the buyer has received these documents, he will

present the transport document to the carrier in order to obtain the goods. After

releasing the goods by

carrier, the applicant (the buyer) takes over the goods and makes all necessary steps

through the customs procedure.

1.4. Why use a Letter of Credit?

The need for a letter of credit is a consideration in the course of negotiations between

the buyer and seller when the important matter of method of payment is being

6

discussed. Payment can be made in several different ways: by the buyer remitting cash

with his order; by open account whereby the buyer remits payment at an agreed time

after receiving the goods; or by documentary collection through a bank in which case

the buyer pays the collecting bank for account of the seller in exchange for shipping

documents which would include, in most cases, the document of title to the goods. In

the aforementioned methods of payment, the seller relies entirely on the willingness and

ability of the buyer to effect payment.

When the seller has doubts about the credit-worthiness of the buyer and wishes

to ensure prompt payment, the seller can insist that the sales contract provides for

payment by irrevocable letter of credit. Furthermore, if the bank issuing the letter of

credit (issuing bank) is unknown to the seller or if the seller is shipping to a foreign

country and is uncertain of the issuing bank's ability to honour its obligation, the seller

can, with the approval of the issuing bank, request its own bank — or a bank of

international repute — to assume the risk of the issuing bank by confirming the letter of

credit.

7

2. TYPES OF DOCUMENTARY CREDITS

There are many features of letters of credit. Some of them are described below. They

can be divided following different rules. By time of payment we have sight or term

documentary credits, by a possibility to revoke we have revocable and irrevocable

letters of credit, then we have confirmed and unconfirmed whether a third bank has

added its confirmation. There are also credits available by payment or negotiation and

other special types which will be also explained in this text.

2.1. Sight or term/usance documentary credits

Letters of credit can permit the beneficiary to be paid immediately upon presentation of

specified documents (Sight letter of credit), or at a future date as established in the

sales contract (term/usance letter of credit). With a sight documentary credit the

beneficiary will receive payment after the presentation of complying documents. With a

usance letter of credit the beneficiary will receive payment on a certain date in future

established by the conditions of a letter of credit. In this case the buyer (the applicant)

wishes to defer payment. Period for deferred payment is usually 30, 60, 90, 120 or 180

days, but there are also longer or even shorter periods stipulated, depending on a type of

business covered by particular documentary credit. Those periods are very often

calculated from the transport document date (shipment date), but other calculations can

be applied depending on specific conditions.

2.2. Revocable or irrevocable documentary credits

Letters of credit can be revocable. Revocable documentary credit is giving to the buyer

flexibility, because it can be changed or revoked without consent of the beneficiary or

even without notifying the beneficiary until payment made by the issuing bank.3 This

means that they can be cancelled or amended at any time by the issuing bank without

notice to the beneficiary, which gives no security for the beneficiary and that is the

reason why they were not used in practical life. However, drawings negotiated before

notice of cancellation or amendment must be honoured by the issuing bank. An

irrevocable letter of credit cannot be cancelled without the consent of the beneficiary.

Revocable letters of credit are not used in practice or its use is very rare. That is why

3 ICC Guide to Documentary Credit Operations for the UCP 500, Charles del Busto, ICC Publication No. 515, 1994 Edition

8

under new rules of the ICC (International Chamber of Commerce in Paris) Uniform

Customs and Practice for Documentary Credits, Publication No. 600 (the UCP 600)

there are no irrevocable letters of credit and there is no such division of letters of credit.

There are only irrevocable letters of credit under new rules i.e. the UCP 600.4

2.3. Unconfirmed or confirmed documentary credits

An unconfirmed letter of credit carries the obligation of the issuing bank to honour all

drawings, provided that the terms and conditions of the letter of credit have been

complied with. Unconfirmed letter of credit simply means that the third or a beneficiary

bank did not put its confirmation and does not guarantee the payment under specified

documentary credit. A confirmed letter of credit has the obligation of another bank that

is normally located in the beneficiary's country, thereby giving the beneficiary the

comfort of dealing with a bank known to him. Confirming bank in this case has added

its confirmation and guarantees the payment to the beneficiary thus decreasing the risk

of the issuing bank. Consequently, confirmed letters of credit are more expensive than

unconfirmed ones. The beneficiary usually requires confirmed letter of credit when the

risk of the issuing bank is high and political risk of the buyer country is high. The

beneficiary can choose for his bank to be confirming bank. In this case it can happen

that beneficiary bank is both confirming and advising bank. When the beneficiary

receives confirmed letter of credit, it has not only the promise of the issuing bank, but

also the obligation of the confirming bank to pay when presents complying documents.

“An unconfirmed letter of credit is no better than the issuing bank and/or its country.”5

According to the UCP500, Article 9b, confirmation of a credit is made by a bank

upon authorization and request of the issuing bank.6 Sometimes it happens that a

beneficiary wants a confirmation by a bank in his country, but the issuing bank and the

applicant did not request for confirmation of the credit. In this case the beneficiary not

wanting to request for the confirmation and amendment of a credit from the issuing

bank can obtain guarantee for the payment from the bank in his own country and this is

so called “silent confirmation”. Some banks are prepared to add its confirmation

4 ICC (International Chamber of Commerce in Paris) rules of the Uniform Customs and Practice for Documentary Credits, Publication No. 600 (the UCP 600)5 Documentary Credits in practice; Reinhard Langerich; First Edition 2000.6 Article 9b of the ICC (International Chamber of Commerce in Paris) rules of the Uniform Customs and Practice for Documentary Credits, Publication No. 500 (the UCP 500)

9

without a request of an issuing bank, and even without informing that bank. A bank

issuing a “silent confirmation” is not protected by the Article 9b of the UCP 500. Some

banks are in favor of this method, while others are against it as they believe it opposes

international rules on documentary credits.7

2.4. Documentary credits available by payment and by negotiation

The difference between these two types of credits is not so clear, even to the bankers. In

some countries it is just the relevant practice that chooses which of these two types will

be used. Documentary credit available by payment means that the nominated or the

issuing bank will release the payment after receiving credit conform documents from

the beneficiary. The nominated bank has no obligation to pay after presentation of

conforming documents under an unconfirmed letter of credit, even if the nominated

bank has found the documents in order. If nominated bank has paid to the beneficiary

then the nominated bank cannot later turn to beneficiary if the issuing bank did not pay

to the nominated bank.

Credit available by negotiation is not clearly defined. It can be available at a

named bank or at any bank. Concept of negotiation is not clearly defined in the UCP

500. Article 10 b ii says: “Negotiation means the giving of value for drafts(s) and/or

document(s) by the bank authorized to negotiate. Mere examination of the documents

without giving of value does not constitute a negotiation.”8 This explanation has caused

many discussions in the world of documentary credits. The term “giving value” is

especially not clear. Different banks in different countries have different approach to the

meaning of the “negotiation”. Usually, the negotiating bank will negotiate (purchase)

the documents (and the drafts drawn on a bank) presented by the seller (the beneficiary

of the letter of credit) if it finds that documents are fulfilling all the conditions of the

documentary credit. When the negotiating bank has been reimbursed by the issuing

bank it will pay the stipulated amount to the beneficiary (seller) of the documentary

credit. If the bank chooses to negotiate the draft presented with the documents and the

seller (the beneficiary) has been reimbursed (paid), then the negotiating bank will have

the right of recourse against the seller according to the relevant national laws on bills of

7 Documentary Credits in practice; Reinhard Langerich; First Edition 2000.

8 Article 10b ii of the ICC (International Chamber of Commerce in Paris) rules of the Uniform Customs and Practice for Documentary Credits, Publication No. 500 (the UCP 500)

10

exchange (drafts) in the country of the seller. This right of recourse lasts until the

drawee bank has paid the draft, that is, when the negotiating bank has been reimbursed

by the issuing bank. According to the Articles 9 a iv and 9 b iv of the UCP 500 credits

available for negotiation can also be issued without a draft and in this case the recourse

right will be based only if the negotiating bank has expressly stated its right of recourse

both when advising and honouring the credit itself. The UCP 500 explains the concept

of negotiation in Article 10 b ii without stating recourse. It means that the negotiating

bank can negotiate without stating its right of recourse depending on specific

agreement. When talking about confirmed credit available by negotiation, the

confirming bank has no right of recourse (article 9 b iv) and in practice there is no

difference between a confirmed credit available by negotiation and a confirmed credit

available by payment.9 The credit must state whether negotiation is to be done by a

named bank or by any bank. Under the UCP 500 the issuing bank cannot make a credit

available at its own place if it calls for negotiation.

Figure 1 – Unconfirmed Sight Documentary Credit: With an unconfirmed sight letter of credit, issuing the letter of credit and payment of funds goes (information flow) from the applicant (buyer) to the beneficiary (seller).

Figure 2 - Confirmed Sight Documentary Credit: With a confirmed sight letter of credit, the issuing and payment of funds also goes from the applicant (buyer) to the beneficiary (seller). However, the payment made by the negotiating/confirming bank (can be two different banks) is made without recourse to the beneficiary.

Figure 3 – Acceptance of the Term (usance) Documentary Credit: On presentation of the documents called for under the letter of credit,

9 Articles 9 a iv, 9 b iv and 10 b ii of the ICC (International Chamber of Commerce in Paris) rules of the Uniform Customs and Practice for Documentary Credits, Publication No. 500 (the UCP 500)

11

BENEFICIARYAPPLICANT

ISSUING BANK NEGOTIATING BANK

BENEFICIARYAPPLICANT

ISSUING BANK NEGOTIATING/CONFIRMING

BANK

provided they are in compliance with its terms, the beneficiary's bank, which may be the advising bank, will send the documents and the draft to the accepting bank for acceptance. The accepted draft may be held by the accepting bank until it matures or it may be returned to the beneficiary at the beneficiary's option, who may hold it until maturity or discount it at the best rate with any bank. The chart below shows the term draft and documents to the beneficiary's bank which, in turn, presents these items to the accepting bank for acceptance.

Figure 4 – Payment of the Term (usance) Documentary Credit: On maturity of the accepted draft, the accepting bank will pay the beneficiary or the discounting bank and claim reimbursement from the issuing bank that will charge the applicant's account and will remit the proceeds. The discounting bank would be any bank which had purchased the accepted draft at a discount. The chart below tracks this procedure. The applicant (buyer) pays the issuing bank that in turn pays the beneficiary or discounting bank through the paying bank.

2.5. Special types of a documentary credit

Up to now we have seen basic types of letters of credit used to cover the shipment of

goods. In addition to these basic types, there are various specialized formats that meet

particular sets of circumstances. Main aim of the letter of credit is to provide security of

the beneficiary, there are some letters of credit providing security to a third party to a

certain extent. That possibility is often used in case when the beneficiary is not producer

12

BENEFICIARY

BENEFICIARY’S BANK

ACCEPTING BANK

BENEFICIARY/DISCOUNTING

BANK

APPLICANT

ISSUING BANK PAYING BANK

of the goods, but has to buy the goods from the producer or sub supplier. Sometimes

when the beneficiary is the producer, he may need to take a loan from his bank for the

raw materials for example, and if the payment is to be made by documentary credit, he

will receive payment not before presentation of documents. The lending bank will want

to have some security for the loan granted, typically it will take security in documentary

credit.

2.5.1. Red clause documentary credit

A red clause letter of credit incorporates a clause, traditionally written in red, which

authorizes the bank acting as the negotiating or paying bank to pay the beneficiary in

advance of shipment. This enables the purchase and accumulation of goods from a

number of different suppliers, and the arrangement of shipment in accordance with the

letter of credit terms. Such advances will be deducted from the amount due to be paid

when the documents called for are presented under the letter of credit. If the beneficiary

fails to ship the goods or cannot do so before the expiry of the letter of credit, the

issuing bank is bound to reimburse the negotiating or paying bank, recovering its

payment from the applicant. Variations of such credits may also require that any

advances be secured by temporary warehouse receipts until shipment is effected.

Beneficiaries of red clause letters of credit are invariably brokers/agents of buyers in a

particular field. UCP 500 and the UCP 600 do not contain provisions concerning this

type of credit. The name for this type of credit comes from a special clause that used to

be highlighted in red ink. This clause in the credit could read as follows:” The

beneficiary may ask for an advance of up to X% of the credit amount in order to make

possible the purchase of the goods. The nominated bank may make such advance

against the beneficiary’s receipt and declaration stating that he will present the

documents in compliance with the stipulations of the documentary credit before

expiration. The advance, including interest, is to be deducted from the proceeds of the

negotiation/payment under this credit. We (the issuing bank) undertake to reimburse the

nominated bank in case the amount advanced should not be repaid. All advances must

be notified to us.”10 This wording means that the nominated bank can demand payment

from the issuing bank in case that beneficiary fails to present documents, or if


13

documents are not in conformity with the terms of the credit. This type of documentary

credit is used today especially in Asian countries where the applicant is willing to take

the risk of the beneficiary’s not delivering the goods.

2.5.2. Green clause documentary credit

It is very similar to red clause letter of credit. The same as with the red clause letter of

credit it is used to enable the beneficiary to obtain advance payment based on the

wording of the credit. The difference is the security provided in the goods. With a green

clause credit the beneficiary should present a receipt for the goods in addition to a

receipt for payment and the statement that he would repay the amount in case of not

presenting docuiments or presenting non conforming documents. A warehouse receipt

should be issued by a independent warehouse and the nominated bank would usually be

indicated as one to take the possession over the goods. The green clasue provides more

security to the issuing bank and to the applicant since they have access to the goods

showing their warehouse receipt.

2.5.3. Transferable documentary credit

A transferable letter of credit allows the beneficiary to act as a middleman and transfer

his rights under a letter of credit to another party or parties who may be suppliers of the

goods. Depending on whether the letter of credit permits partial shipments, fractional

amounts may be transferred to more than one beneficiary. Each of these beneficiaries

can reject the possible future amendments just for the fractions concerning them.

Transfer of a letter of credit can be made on specific application by the original

beneficiary to the authorized transferring bank

To be transferable, a letter of credit must be so marked by the issuing bank

which can only do so on the applicant's specific instructions. In case of a transferable

documentary credit the shipment is made by a third party, who is often unknown to the

applicant.

The terms and conditions of the transferred letter of credit must be identical to

those of the original letter of credit with the following exceptions:

• The original beneficiary may be shown as the applicant on the transferred credit.

• The amount of the letter of credit, and unit prices if any, may be reduced and less

than in the original letter of credit (the difference being the original beneficiary's profit

margin).

14

• The latest shipment date, if any and expiry date as shown on the original letter of

credit can be changed to an earlier date

• The percentage of insurance coverage, if any, should be increased to meet the

requirements of the original issued documentary credit.

• When a drawing takes place, the original beneficiary normally substitutes his

invoices for those of the second beneficiary for up to the amount and unit prices

available under the original letter of credit, and draws the difference as profit.

The first beneficiary does not want for the applicant to know the third party because in

this way they could bypass the first beneficiary doing business independently. The

applicant does not know the buying price, and likewise the third beneficiary/supplier

does not know the selling price. Article 48 of the UCP 500 says that if all other rules

and conditions are met, the transferring bank does not bear any credit risk, even though

bears a significant handling risk due to more complex structure of such a credit. A

documentary credit can only be transferred if it is expressly stated as “transferable” by

the issuing bank according the Article 48 of the UCP 500. Only the nominated bank as

transferring bank can transfer the credit. The transferring bank does not have to effect

the transfer itself and many banks demand that the credit should be available at

themselves in order to make the transfer. Unless it is not stated in the credit it can be

transferred only once. This means that if it not expressly stated in the credit it cannot be

transferred by second beneficiary to a third party, but it can be retransferred to a first

beneficiary and then again transferred to a third party.11 Transferred letter of credit is

often regarded as two closely connected payments and security instrument rather than

one. There can be some problems when there are several beneficiaries, especially

dealing with amendments where the second beneficiary can reject the amendment in

case of approval of the first beneficiary. Therefore the first beneficiary can give the

instructions to the transferring bank whether he has to be asked from the side of the

transferring bank about its amendments to the second beneficiary or those amendments

can be done without the consent of the first beneficiary. If it is not differently stated in a

credit, the first beneficiary can freely choose in whose favor and in which country the

credit can be transferred at. If the credit is not marked as transferable it will not prevent

its proceeds to be assigned to the third party, but within the national law frame

11 Article 48 of the ICC (International Chamber of Commerce in Paris) rules of the Uniform Customs and Practice for Documentary Credits, Publication No. 500 (the UCP 500)

15

regarding assignments. The credit proceeds can be transferred in two ways: by

assignment of proceeds by notification and by issuing irrevocable payment order.

2.5.4. Back to back documentary credit

Although not written on a letter of credit wording, "back-to-back" is a term used in

transactions involving two letters of credit. The main difference with transferable

documentary credit is that a back-to-back credit is separate credit based on another

issued documentary credit. It is not even mentioned in the UCP 500 or UCP 600. Both

credits are independent instruments, both subject to the UCP 500 or the latest version

the UCP 600 (usually for credits issued after 1st of July 2007 being the date of coming

into force of the UCP 600).

Such transactions originate when a seller receives a letter of credit covering

goods that must be obtained from a third party that in turn requires a letter of credit. The

"second" issuing bank looks to the first issuing bank for reimbursement after paying

under the second letter of credit.

The difference between back-to-back letters of credit and transferable letters of

credit is such that in a transferable letter of credit, the rights under the existing letter of

credit are transferred. In a back-to-back transaction, different letters of credit are

actually issued. Because technical problems can arise in back-to-back transactions,

banks tend to discourage their use.

There are several reasons for using back-to-back letters of credit. First of all the

applicant would lose some security and control over the transferable credit. The

beneficiary also want to leave the impression that he does not need this kind of security

to obtain the goods from the third party and he wants to have the possibility to make

changes in the credit that is to be issued to the third party.

2.5.5. Deferred payment documentary credit

Under a deferred payment letter of credit, the applicant does not pay until a future date

determined in accordance with the terms of the letter of credit. No drafts are called for,

which avoids "stamp duties" charged by some countries on bills of exchange (drafts).

One reason an exporter might extend credit terms to an importer could be the

competitiveness of the market and the need for the exporter to finance the importer if

the exporter is to make the sale.

16

2.6. Other types of documentary credits

The letters of credit described thus far cover the movement of goods from one

destination to another. There are other types of letters of credit that are not specifically

related to the movement of goods. The principal one is as follows:

2.6.1. Standby letters of credit

Standby letters of credit may apply in general to transactions that are based on the

concept of default by the applicant in fulfilling contractual obligations. In the event of

default, the beneficiary is permitted to draw under the letter of credit. A standby letter of

credit can be defined as a bank guarantee taking the shape of a documentary credit and

being subject to the UCP rules. Standby letters of credit may be used as a substitute for

performance guarantees, or issued to guarantee loans granted by one firm to another,

thereby securing payment to the creditor in the event the other party fails to repay its

obligation on the due date. They are used in the same way as bank guarantees. Like the

bank guarantee a standby letter of credit is not to be used unless parties do not fulfill

their obligations. This type of letter of credit was firstly used in the USA to substitute

bank guarantees. Standby letter of credit represents the obligations of the issuing bank

to the beneficiary. This obligation can take various forms, but mainly it can be the

obligation of returning the money to the beneficiary which was lent (or advanced) to the

applicant, to make the payment to the beneficiary or to make a payment to any party if

the applicant does not effect the payment.12 Even if the applicant claims to have

performed, the bank issuing the letter of credit is obliged to make payment provided the

beneficiary produces complying documents, usually a sight draft, and a written demand

for payment. As in commercial letter of credit the beneficiary should present the

documents, but in the case of standby letter of credit instead of presenting invoices,

transport documents and other, the seller/the beneficiary should present a written

demand for payment saying that the applicant did not meet his contractual obligations.

This written demand can often be accompanied with other documents depending on the

stipulations of each standby letter of credit.

Today may prefer to use a standby rather than an ordinary guarantee since the

standby is subject to the ICC Uniform Customs and Practice for Documentary Credits

12 ICC Guide to Documentary Credit Operations for the UCP 500, Charles del Busto, ICC Publication No. 515, 1994 Edition

17

and the ICC International Standby Practices (ISP98), because the ICC Uniform Rules

for Demand Guarantees (URDG 458) has not yet gained international acceptance to the

wanted level. We have already said that standby letter of credit was created in the USA

and most standbys are issued by US banks and in countries influenced by US banking,

such as East Asia for example. US banks were then not allowed to issue bank

guarantees under US law. Today they can issue a bank guarantee, but only if they are

payable against the presentation of documents (demand guarantees).The use of standbys

is now very spread, although between European countries it is not so common.13 In the

USA particularly it is spread financial standby letter of credit used to secure various

financial transactions such as loans, overdraft facilities, obligations under issued bonds

or mergers and acquisitions.

As for the rules governing standbys letters of credit they are basically the

same as with commercial letter of credit (UCP 500 or UCP 600), but as from January

1999 specific rules took effect (ISP98). As with bank guarantees, standbys can state that

particular national laws are applicable in case of dispute. Standbys used in USA are

subject usually to the US Uniform Commercial Code (UCC). International Standby

Practices (ISP98) is separate set of rules for standby letters of credit and they are

introduced because the UCP500 was not detailed enough regarding standbys. ISP98

were published jointly by the ICC and the Institute of International Banking Law and

Practice.

13 Documentary Credits in practice; Reinhard Langerich; First Edition 2000

18

3. BENEFITS OF A LETTER OF CREDIT

3.1. Benefits for the Exporter/Seller

• Letters of credit open doors to international trade by providing a secure

mechanism for payment upon fulfillment of contractual obligations. This

guarantee element in the letter of credit is one of the most important. Today a

great deal of international trade is done by parties not knowing enough of each

other and in this way risk in international trade is reduced. Since the

documentary credit is issued by the bank (issuing bank), the risk to the buyer is

transferred to the issuing bank that irrevocably undertakes to pay to the

seller/exporter for the shipped goods.

• In addition the seller can rest assured that he will receive payment on time as

agreed in terms and condition of the sales contract and letter of credit. Thus, the

seller/exporter secures his liquidity and cash flow by knowing the exact time of

incoming cash flows under issued letters of credit.

• A bank is substituted for the buyer as the source of payment for goods or

services exported.

• The issuing bank undertakes to make payment, provided all the terms and

conditions stipulated in the letter of credit are complied with.

• Financing opportunities, such as pre-shipment finance secured by a letter of

credit and/or discounting of accepted drafts drawn under letters of credit, are

available in many countries.

• Bank expertise is made available to help complete trade transactions

successfully.

• Payment for the goods shipped can be remitted to your own bank or a bank of

your choice.

3.2. Benefits for the Importer/Buyer

Basically, letter of credit is known as the “seller’s instrument”. Usually if trading on

open account basis is available, the buyer/importer will not ask for the documentary

credit. But, there are also some advantages on the buyer’s side.

• Payment will only be made to the seller when the terms and conditions of the

letter of credit are complied with.

19

• Buyer is receiving goods instead of money so he is interested to secure obtaining

goods, as stipulated in letter of credit, which is in good order. This is secured as

in previous point when the terms and conditions of documentary credit are in

compliance with the stipulated documents presented.

• The importer can control the shipping dates for the goods being purchased.

• Cash resources are not tied up. Sometimes the buyer can stipulate deferred

payment only in case of trading done through documentary credit that greatly

reduces risk for the seller. In this way buyer can obtain low cost finance and

improve his liquidity and cash flow situation.

• Sometimes the seller may have a need to finance buying raw materials or parts

for the goods to be exported later under documentary credit. If he is

creditworthy he can obtain an advance from his bank based on the documentary

credit.

• In some countries it is necessary for the importer to demand issuance of the

documentary credit. It is legally binding for the importer if he wants to import

the goods. This regulation in some countries is applied to all imports, while in

others may be applied only on specific type goods. These regulation are often

used in countries with large misbalance in trade, usually in South America, Asia

and Africa.

• After some time partners in international trade may agree to leave the

documentary credit as a mean of payment and switch to an open account that is

cheaper and more efficient. This usually happens when partners get to know

each other and where is no need to use documentary credit based on the previous

experience. But, in some cases they continue to use documentary credits because

they do not want to bother with the dates of payment. Bank’s departments take

care of such details.14

3.3. Disadvantages of the documentary credits

• Documentary credits can be expensive tool of payment and security in

international trade, since they mean considerable workload. All the documents

have to meet conditions stipulated in the credit, no matter if they seem not

important for the beneficiary (seller).


20

• Issuance of the documentary credit can take time and this time may seem long

for the seller as well as for the buyer. This could be problem when seller and the

buyer have already agreed exact dates for the shipment of the goods. In some

countries import license or payment license is required by the national banks and

this takes time. The issuing bank has to assess the credit ability of the buyer

before issuing documentary credit, which is also time taking. Because all of this,

seller may not be able to meet the terms and conditions, especially regarding

dispatch of the goods. Seller usually has to wait for the issuance of the

documentary credit in order to dispatch the goods.

• In general some advantages for the seller are disadvantages for the buyer. For

example, change in the price of the goods, or other market change cannot be

overlapped in case of the complying presentation of the documents. In such case

amendment can be done only with the consent of both sides.

3.4. Risks in using documentary credits

Seller’s risk is basically the risk of the issuing bank. Issuing bank is most commonly

buyer’s bank in a distant country. Documentary credit is as good as the bank that

guarantees the payment. This risk can be avoided by issuing confirming documentary

credit. This type of the letter of credit is confirmed by the third bank (or beneficiary

bank), which in this way takes the risk of the issuing bank.

The buyer bears the risk of receiving the goods in a poor state or not receiving

the goods at all. The buyer also bears the risk of documents being lost in the transit.

There is also a risk of the fraud, but this risk is very low. Frauds in documentary credit

business are very rare.

21

4. GOVERNING LAW AND RULES FOR DOCUMENTARY CREDITS

In the beginning there were no rules governing documentary credit business.

Relationships between two parties were based on their mutual agreement. Banks began

to establish rules in this field, but this was not enough, since there were not general

rules that could be applied. In the early 20 th century banks in different countries agreed

to set up national rules for handling documentary credits. We should mention that back

then existed many national rules, such as London banks rules, Paris banks rules and etc.

International Chamber of Commerce (the ICC) was founded in 1919 by a small

group of international business people as a private international trade organization.15

The aim of this organization was to promote international trade and to provide some

general rules for cross border trade. Today the ICC developed into a powerful

organization supported internationally. It is divided into several commissions. Banking

commission is founded to bring and interpret uniform rules relating to documentary

credits, documentary collections and banking guarantees. The ICC is represented in

more than 130 countries.

4.1. Uniform Customs and Practice for Documentary Credits (UCP)

The Uniform Customs and Practice for Documentary Credits (UCP) is an

internationally agreed set of rules for all parties involved in all types of documentary

credit transactions. The first version of the ICC Uniform Customs and Practice for

Documentary Credits was adopted at the ICC congress in Amsterdam in 1929. Only

limited number of countries used these rules and the first revision was adopted in

Vienna in 1933.They have been revised several times and are now used by banks all

over the world. After the revision in 1962 British banks adopted the rules and so did the

other banks influenced by trade with Great Britain. That was the major breakthrough so

these rules became truly international.

The Uniform Customs and Practice for Documentary Credits, currently

applicable, is a set of rules which, when not in contravention of local laws, are binding

on the parties who have adopted them. The authority of UCP lies in its universal

acceptance that is acknowledged by a statement on the letter of credit itself. They are

not statutory rules and as such they have only legal effect on an agreement. One of the

15 www.iccwbo.org - International Chamber of Commerce (ICC) – The world business organization

22

http://www.iccwbo.org/

latest revisions took place in 1993 with the official title being ICC Uniform Customs

and Practice for Documentary Credits, 1993 Revision, ICC Publication No. 500 often

referred to as the UCP 500. The latest revision happened in 2007 and took effect from

the 1st July 2007 being the ICC Uniform Customs and Practice for Documentary

Credits, 2007 Revision, ICC Publication No. 600 referred to as the UCP 600.

We have to also mention some other rules such as International Standby

Practices or ISP98. The UCP 500 with its provisions also deals with Standby Letters of

Credit, which can be described as a banking guarantee taking form of a documentary

credit. But, banks and lawyers in the USA wanted to have more specific rules regarding

Standby Letters of Credit. The ISP98 was published jointly by the ICC, the Institute of

International Banking Law and Practice and the IFSA, the US banking organization for

international banks.

4.2. General Principles of UCP

Letters of credit are separate transactions from the sales or other contracts on which they

may be based, and banks are in no way involved with or bound by such contracts, even

if reference to them is included in the letter of credit. In letters of credit transactions, all

parties deal with documents and not with the underlying contracts to which the

documents may relate. Before payment or acceptance of drafts is effected, banks bear

the responsibility for examining the documents to ensure that they appear on their face

to be in accordance with the terms and conditions of the letter of credit. Banks bear no

responsibility for: the form or genuineness of documents; for the goods described in the

documents; or the performance of the seller of the goods.

4.3. Legislation and documentary credits

We need to say that only few countries have specific rules concerning documentary

credit transactions. At the contrary there are few countries that consider Uniform

Customs and Practice (UCP) within their own law thus giving them more power. Both

of these methods are making some problems in practice. First one is based on court

decisions of the judges that are making decisions not in accordance with UCP rules.

Many of these judges are also making wrong decisions because they have not enough

experience and knowledge on UCP rules and documentary credits in general. Other

problem concerning countries putting UCP rules as a part of their legislation is that after

revisions those laws are still on power, even though in practice newly issued letters of

23

credits are subjected usually to the latest revision, while others which are still existing

are based on older revision. In many lawsuits documentary credit is considered to be an

ordinary contract. Documentary credit cannot replace a purchase agreement or a sales

contract. It is not signed by two parties as a contract. It is only a promise given by the

bank to the seller that is to be fulfilled in case all conditions are met. Fortunately vast

majority of the documentary credit transactions are settled without any problems.

The USA has had its own trade legislation for many years. It is called the

Uniform Commercial Code (UCC) and Article 5 deals with documentary credits. This

specific legislation has had big influence on judicial decisions regarding documentary

credits, even those one clearly stated that are subject to ICC international rules. In recent

years we have seen reinforcement of the ICC rules in USA and judges are increasingly

paying attention to this. The Article 5 of UCC has also been revised stating that if the

credit has been issued in accordance with ICC UCP rules, those rules are to be applied.

4.4. Basis for opening a documentary credit

Before an opening of a documentary credit there has to be an agreement between the

buyer and the seller taking various form, but usually being a sales/purchase written

contract or accepting an offer by the buyer in a more informal way (in a case when

buyer and seller know each other very well). Such contract normally includes

information about description of the goods (including percentage of tolerance in

quantity and value), total and unit price including discounts and different charges

(freight charges for example), terms of delivery (INCOTERMS or other terms), date of

delivery, information on whether partial shipment is allowed, terms of payment, basic

information on documentary credit such as the type, nominated bank, confirming bank

if needed, charges (who bears the charges), expiry date and latest date of shipment,

documents required and etc. After the contract is done it will make a basis for the

application form of the buyer to the issuing bank for the opening of a documentary

credit. The buyer must provide all necessary details to the issuing bank regarding

opening of the documentary credit if they are missing from the sales contract or order

accepted by the buyer.

The documentary credit should fulfill some requirement as for the seller as well

as for the buyer. Each letter of credit should suit specific needs of the seller and the

buyer. There is no standardized perfect wording of the one documentary credit.

24

The seller should ensure that the amount of the documentary credit is fair and

correct, a seller should state whether the credit is to be issued for a fixed amount, a

maximum amount or an approximate amount (with percentage of tolerance allowed in

value), then the seller should choose whether partial shipment and transshipment are

permitted, appropriate term of delivery should be chosen, additional payments should be

taken into consideration and entered into letter of credit, the seller should take care to

put realistic date(s) of shipment and date(s) of expiry, the period for presentation of the

documents should not be too short, documents required should also be agreed before

opening of a documentary credit, the seller should also demand that the description of

the goods should be brief and general and should prevent the buyer to put the article that

pro-forma invoice forms an integral part of a documentary credit (too detailed

description of the goods could lead to problems when drafting documents).

The most important thing for the buyer is to receive goods at the price and time

agreed and in agreed quality and quantity. While determining documents required, the

buyer is interested in having those documents to ensure that the transaction will be

executed as agreed and that he gets the access to the goods in order to have them cleared

through the customs. The buyer will want the credit to be issued as cheap as possible, he

will want to keep amount as low as possible, then if the buyer is the one that pays the

charges he would want the goods to be shipped from a place with the lowest charges.

The buyer has to consider insurance as a security for the goods. All other terms should

be also considered and agreed upon. As in documentary credit operations parties deal

with the documents and not with the goods, it is in buyer’s best interest to demand

detailed and many documents, which prove that everything is in order with his goods.

The most important documents that are usually required are:

o Invoice

o Transport document (Bill of lading, air waybill or other)

o Insurance document (Insurance policy or insurance certificate)

Other documents demanded by the buyer are the ones needed for the customs:

o Certificate of origin

o Health certificate

o Import or export license

o Consular invoice

25

o EUR 1 - Certificate of origin

Sometimes buyer will demand some other documents needed for his own use or for

other reasons and those documents can be:

o Inspection certificate

o Packing list

o Guarantee issued by the seller or producer

There is no restriction considering the number of the documents required, but the buyer

should take into account not to demand many documents, because this can be annoying

to the seller or make problems in executing the transaction.

The buyer/applicant should fulfill application form for the opening of a

documentary credit. The application form is prepared by the issuing bank. The

application form serves to inform the bank about all necessary details in connection

with the documentary credit. These details usually are full and correct name and address

of the applicant and the beneficiary, type of credit, the date of expiry, latest date for the

presentation of the documents plus period for presentation of documents (if nothing is

stated 21 days are applied) which gives the date of expiry, place for presentation of the

documents, name of the advising and confirming bank, the amount and currency of the

credit, description of the goods, documents required, the place of shipment, whether

partial shipment and transshipment is allowed or not, agreed terms of delivery and

payment, who is paying bank charges and other details depending on the bank.

Other things that banks are demanding are different. Bank has to have some

arrangements and determined relationship in form of contract with the applicant.

Applicant is not a party in the letter of credit transactions. Issuing bank is the one

obliged to fulfill obligations coming from documentary credit. That is why the bank

should establish clear agreement with the applicant. By signing the application the

applicant accepts all rules regarding documentary credit (UCP 500 or UCP 600). The

applicant has the obligation to reimburse the bank for all the payments and expenses

connected with the documentary credit and that is why it is important to have a contract

between the applicant and the issuing bank. After submitting application form, bank

should examine the application and if it is correct and precise it should issue the letter of

credit in question, of course after all procedural things being completed and in order.

26

Under a documentary credit we saw that issuing bank is obligated to meet all

obligations (correctness and payment). Issuing bank should effect the payment to the

beneficiary of the letter of credit after conforming documents being received. The

applicant has the right to refuse non complying/non conforming documents, in which

case payment is not made and the goods rest in possession of the beneficiary. Having in

mind the above mentioned, the bank should examine the creditworthiness of the

applicant before going into procedure of issuing of the letter of credit. The applicant

should be able to pay the amount of the issued letter of credit on a due date that can be

also in future (long term due date of the letter of credit).

Another important point is that the applicant pledges the documents

(representing the goods) to the issuing bank. They can also serve as a security for the

bank, because the bank can without the knowledge of the applicant take possession over

the goods. If the bank wants to have easy access over the goods it should be noted as

consignee in negotiable documents proving ownership over the goods such as Bill of

Lading. If the bank is noted as consignee in the Bill of Lading that means it is legal

owner over the goods, and in this manner those goods can serve as security or collateral

for the issuing bank. Also insurance should be taken into consideration, because

damaged goods cannot serve as security in this case.16


27

5. THE ISSUANCE OF DOCUMENTARY CREDIT

The issuance of the letter of credit is most often required by the seller, but the buyer

instructs his bank to issue the letter of credit based on agreement with the seller. The

issuing bank is responsible for the credit, its wording and correctness and in that manner

it has to take care not to make mistakes while issuing documentary credit.

5.1. Issuance and handling by the issuing bank

Issuance is based on the applicant’s instructions and most banks have their own

application form serving as gathering information from the applicant on the features and

conditions of the documentary credit wanted by the applicant. Application form can be

filled out manually or electronically depending on the issuing bank. The bank has to

provide each credit with the unique reference number in order not to have confusion

while handling with the credit and interacting with parties involved such as other banks.

Each credit has to be booked and evidenced in issuing bank’s system. Before the

development of electronic means, documentary credits were printed out on paper and

sent to the advising bank by air mail. The text of the credit was written on bank’s

special form. Sometimes the credit was issued using telex or cable communications

(higher costs). In the 1980s S.W.I.F.T. was enabled to work with documentary credits.

S.W.I.F.T. (Society for Worldwide Interbank Financial Telecommunication) is based in

Brussels, Belgium and was founded and owned by many world banks. It serves to

establish and maintain an electronic network connecting all interested banks.17 These

banks can send each other various information, usually formatted uniquely and through

a very secure network. The use of S.W.I.F.T. reduced telecommunication costs and now

the most number of banks are using S.W.I.F.T. network in communication between

each other (payments, cheques, term and overnight deposits, documentary collections,

bonds and commercial papers trade, documentary credits and bank guarantees,

statements and other).

If the issuing bank has no direct relationship with the beneficiary bank

(S.W.I.F.T. bilateral keys exchanged) than it cannot transmit documentary credit

directly to the beneficiary bank. Issuing bank has to go through one of its correspondent

banks, which will find a way to advise the credit to the beneficiary bank named in the

17 www.swift.com – S.W.I.F.T. (Society for Worldwide Interbank Financial Telecommunication)

28


application form, invoice or pro-forma invoice. If the applicant does not request the use

of specific bank, the issuing bank will choose one bank based on its previous experience

and knowledge of the banks in the country of the beneficiary, in order to advise the

beneficiary of the credit. Today the biggest international banks run a network consisting

of several thousand banks found all over the world.

5.2. Liability of the issuing bank

We have already said that the issuing bank is responsible for the issuance, form,

contents wording and payment under documentary credit. Article 3 of the UCP 500

states that documentary credits are separate transactions from all the contracts and

agreements on which they are based. Article 4 of the UCP 500 says that all parties

involved are dealing with the documents and not with goods, meaning that the bank

must approve credit conform documents even if there are suspicions that there is

something wrong with the goods. According to the Article 5 of the UCP 500 all

wording and amendments must be precise and complete. Over detailing and

misinterpretation should be avoided. Issuing bank cannot be responsible for the

beneficiary’s ability to meet credit requirements. Very important is Article 9 a of the

UCP 500 describing the liability of the issuing bank. It says that documentary credit

constitutes a definite payment undertaking of the issuing bank, provided that the

stipulated documents are presented to the nominated bank and that the terms and

conditions of the credit are complied with. This means that the issuing bank has to pay

to the beneficiary in case of presentation of credit conform documents. 18

5.3. Contents of the documentary credit

Contents of the documentary credit will vary from credit to credit. There has to be a

wording stating rules applied for particular letter of credit such as the UCP 500 or UCP

600. Than each credit should be assigned by unique number which is important for

future handling and correspondence. By assigning unique number, each credit can be

easily identified. Majority of issued credits are transmitted by the issuing bank to one of

its correspondent banks instructing them to advise the credit to the beneficiary. The

applicant can choose preferred advising bank instructed usually by the beneficiary. The

credit can be issued and transmitted directly to the beneficiary bank only in case if the

18 ICC (International Chamber of Commerce in Paris) rules of the Uniform Customs and Practice for Documentary Credits, Publication No. 500 (the UCP 500)

29

issuing and the beneficiary bank have exchanged list of authorized signatures and

telegraphic keys (S.W.I.F.T. bilateral keys) and if the credit does not have stated third

advising or confirming bank. If the issuing bank has bad business experience with the

bank noted in the credit by applicant as advising, it should inform the applicant and

suggest another bank.

Things regarding type and form of the credit usually come from the application.

Today, credits issued under the UCP 600, do not have to state whether they are

revocable, since there is no more possibility to issue revocable letters of credit. There is

instruction about whether the credit is confirmed or unconfirmed, than the credit must

clearly state if it is available by sight payment or deferred payment, by acceptance or by

negotiation. Since, the issuing bank has to pay after presentation of credit conform

documents, it is good to have reimbursement instructions or how the issuing bank will

pay to the nominated bank. The issuing bank’s payment to the honouring bank will be

effected according to three principles:

The issuing bank authorize the nominated bank to authorize its account

The issuing bank authorizes a third bank (reimbursement bank) to

honour the nominated bank’s claim under the credit

The issuing bank transfers the amount upon a request from the

nominated bank19

The credit often states how the documents are to be send to the issuing bank, and the

address on which the documents are supposed to be sent. The issuing bank does not take

the responsibility if the documents are sent to the wrong address.

Other contents of the letter of credit are coming from the agreement between the

buyer and the seller. The credit must clearly state the full name and the address of the

beneficiary of the credit. The beneficiary should be the right one because sometime the

goods are not produced and sold by the same company. Description of goods should be

written as briefly and precisely as possible with stated terms of delivery (FOB, EXW,

FAS, FCA or CIF for example), usually being INCOTERMS 2000 which are

International Commercial Terms defining the responsibilities of buyer and seller for

delivery of goods under sales contracts. Incoterms 2000 is the authoritative text for

determining how costs and risks are allocated to the parties. Incoterms 2000 contains


30

the official ICC text of the thirteen trading terms taking into account the latest

development in commercial practice. 20

Amount of the credit should be denoted in the correct currency. It represents the

amount that should be paid to the beneficiary after presentations of the documents. If

there is only currency and the amount it means that the credit is issued for that amount

precisely. If there are no specific conditions about the quantity of the credit, a tolerance

of 5% more or less is allowed in quantity. The tolerance of less 5% in a credit amount is

allowed provided the partial shipments are not allowed. The credit amount should not

exceed stated amount if not differently stipulated. If the credit has the wording “not

exceeding” it means that the amount could be lower than stipulated. There is a field

“percentage amount tolerance” which determines eventual percentage of tolerance in the

amount being more or less.

The credit should clearly indicate which documents are to be presented by the

beneficiary. Description of the documents should be clear and not ambiguous. Applicant

quotes needed documents in the issuing bank application form.

5.4. Advising the letter of credit and obligation of the advising bank

After the issuing bank has transmitted the credit to one of its correspondent banks, the

credit is advised to the beneficiary. The beneficiary usually receives notification of

issued letter of credit in his favor by his bank. That way beneficiary can be certain that

the issued credit is genuine. He does not have to check authenticity of the credit and

authorized signatures of the issuing bank. That is done by advising bank. Generally, the

advising bank has no obligations under the credit. Issuing bank has the obligation to pay

to the beneficiary. From Article 7 of the UCP 500 the advising bank may elect to advise

the credit, meaning it can reject to advise the credit. If it does so, it has to inform the

issuing bank without delay. Also with accordance of this article, the advising bank must

establish the apparent authenticity of the credit. If it cannot establish apparent

authenticity of the credit it must without delay inform about that the issuing bank.21 The

reasons for rejecting of the advising by the advising bank may be different. For

example, the advising bank may have had poor previous experience with the issuing

20 Incoterms 2000, ICC Official Rules for the Interpretation of Trade Terms ICC Publication No. 560, 2000 Edition21 Article 7 of the ICC (International Chamber of Commerce in Paris) rules of the Uniform Customs and Practice for Documentary Credits, Publication No. 500 (the UCP 500)

31

bank, or issuing bank didn’t handle very well the credit. Then, there is a question of the

country where operates the issuing bank and the legislation of that country or imposed

possible embargos and political situation. Also the type of goods may be problematic

(weapons, forbidden chemicals etc.). If the purpose of the letter of credit cannot be

determined by the advising bank it may refuse advising in order not to be involved in

money laundering activities.

When receiving the credit by telecommunication means (S.W.I.F.T. or telex) the

advising bank will first check the authenticity of the credit by verifying test keys. If the

credit is issued by letter, the advising bank will check the authorized signatures on the

credit with the ones received from the issuing bank. In addition, it will usually ask the

issuing bank to confirm the authenticity of the credit by S.W.I.F.T. Then it will forward

the credit to the beneficiary.

The advising bank is not liable to examine the documents presented even if it

has advised the credit. But the nominated bank has to respect 7-day rule under the UCP

500, concerning refusal of non-conforming documents. A nominated bank that does not

want to honour or examine the documents must inform the beneficiary accordingly

when advising the credit, or at the latest upon presentation of the documents. If the

advising bank has confirmed the credit or has given the” silent confirmation” than it has

obligations under that credit as the confirming bank.

The beneficiary should examine the credit as soon as he receives it. The purpose

is to prepare correct documents and to check whether the credit conforms to all the

terms and conditions agreed before. The beneficiary should check if it complies with

sales contract, pro-forma invoice or other documents and conditions agreed. The banks

take care only for details in the credit itself and not to any agreement between the seller

and the buyer. If the beneficiary finds that the credit has not been issued in accordance

with the terms and conditions than it should ask the amendment of the credit.

5.5. Amendments of the documentary credit

Amendments of the credit are common practice in today’s world of documentary

credits. If the beneficiary establishes that the credit is not issued under terms and

conditions agreed or it is erroneous, it will ask for an amendment. It can also happen

that the seller and the buyer agreed in the meantime about changing their agreement.

32

This change can also call for an amendment. Then, the delay in production or other

difficulties can cause an amendment of the letter of credit in stake.

In the procedure of amending the letter of credit, the beneficiary has to ask the

applicant to arrange an amendment with the issuing bank. The issuing bank is prepared

to amend the credit after the instructions received by the applicant. If the issuing bank

amend the credit only on beneficiary’s demand or by instructions of the advising bank it

will risk that the credit amendment will not be accepted by the applicant and that the

documents will be rejected by the applicant as non conforming. When advising the

amendment the issuing bank must use the same bank as with the issuance of that credit

according to the article 11 b of the UCP 500.Article 9 d of the UCP 500 says that an

amendment can be made only with the agreement of the issuing, confirming bank (if

any) and the beneficiary.22 Any amendment made by the issuing bank is bounding for

the issuing bank. Those amendments are also bounding for the confirming bank, if the

credit is confirmed. If the confirming bank rejects to accept the amendment it is still

liable by the original credit according to the Article 9 d of the UCP 500 and it has to

inform the issuing bank and the beneficiary about it. The terms of the original letter of

credit will be in force until the beneficiary accepts the amendment. If the beneficiary

stays silent, after the presentation of the documents based on the amendment, it is

considered that amendment is accepted. The partial acceptance of an amendment is not

permitted.

Example 1 – Issuance of the documentary credit by S.W.I.F.T.

MT 700 – Message type 700SENDER: OSBAATWW (S.W.I.F.T. address of the issuing bank)

Ost Bank AGKarlstrasse 54Vienna, AT

RECEIVER: ARBAGRAA (issuing bank’s correspondent bank)Argo Bank Athens, GR

:27: SEQUENCE OF TOTAL1/1:40A: FORM OF DOCUMENTARY CREDITIRREVOCABLE TRANSFERABLE:20: DOCUMENTARY CREDIT NUMBER55/LC/1234N:31C: DATE OF ISSUE070523

22 Articles 11 b and 9 d of the ICC (International Chamber of Commerce in Paris) rules of the Uniform Customs and Practice for Documentary Credits, Publication No. 500 (the UCP 500)

33

:31D: DATE AND PLACE OF EXPIRY071121 CHINA:50: APPLICANTAUTON EXPORT AGVERSTRASSE 45VIENNA, AT:59: BENEFICIARYCHINA CHAIN CORP.FENG STR. 18BEIJING, CHINA:32B: CURRENCY CODE, AMOUNTEUR111000,00:39A: PERCENTAGE CREDIT AMOUNT TOLERANCE10/10:41A: AVAILABLE WITHOSBAATWWBY PAYMENT:43P: PARTIAL SHIPMENTSALLOWED:43T: TRANSSHIPMENTALLOWED:44A: SHIPMENT FROMANY CHINESE PORT:44B: FOR TRANSPORTATION TOVENICE, ITALY:44C: LATEST DATE OF SHIPMENT071101:45A: DESCRIPTION OF GOODS111222 PCS OF TEXTILE GARMENTS ACCORDING TO THEPROFORMA INVOICE NO. 123 DTD 11.01.2007.+ FOB ANY CHINESE PORT (INCOTERMS 2000):46A: DOCUMENTS REQUIRED+ INVOICE IN THREE COPIES, SIGNED AND STAMPED BY THE APPLICANT+ PACKING LIST IN THREE COPIES+ FULL SET CLEAN ON BOARD BILL OF LADINGISSUED TO THE ORDER, BLANK ENDORSED, NOTIFY APPLICANT, MARKED FREIGHT COLLECT+ CERTIFICATE OF ORIGINE IN THREE COPIES+ GSP CERTIFICATE OF ORIGIN FORM A IN THREE COPIES:47A: ADDITIONAL CONDITION+ THIS DOCUMENTARY CREDIT IS ONLY TRANSFERABLE WITH THE ADVISING BANK+ GSP CERTIFICATE OF ORIGIN CAN BE ISSUED ON LANGUAGE OTHER THAN ENGLISH+ DISCREPANCY FEE IN THE AMOUNT OF EUR 50,00 WILL BE CHARGED BY US IN CASE OF DISCREPANCIES FOUND IN THE DOCUMENTS+ ONE EXTRA COPY FOR ALL THE DOCUMENTS NEEDED FOR OUR FILES:57A: ACCOUNT WITHEXBABECN (EXPORT BANK OF CHINA):71B: CHARGESALL CHARGES OUTSIDE AUSTRIA ARE FOR THE BENEFICIARY’S ACCOUNT:48: PERIOD FOR PRESENTATION21 DAYS:49: CONFIRMATION INSTRUCTIONSWITHOUT:49: INSTRUCTIONS TO THE PAYING/ACCEPTING/NEGOTIATING BANKUPON RECEIPT OF CREDIT CONFORM DOCUMENTS AT OUR COUNTERS WE WILL REMIT FUNDS AS PER YOUR PAYMENT INSTRUCTIONS:72: SENDER TO RECEIVER INFORMATIONPLEASE FORWARD THE DOCUMENTS BY COURIER TO OUR ADDRESS: Ost Bank AG, Karlstrasse 54, Vienna, Austria

34

6. MAJOR STEPS IN AN IMPORT/NOSTRO AND EXPORT/LORO

DOCUMENTARY CREDIT TRANSACTION

Before moving on to the steps regarding import and export letter of credit, we will

briefly explain the meaning of those two different terms. Basically when talking about

import or export credit we have to know that one letter of credit is import/nostro credit

for the issuing bank and export/loro for the beneficiary bank. The following text will

briefly show major steps while handling documentary credit, both on the side of export

and import.

6.1. Import/nostro letter of credit

Before everything the creditworthiness of the applicant should be evaluated and there

has to be a decision on granting the issuance of the letter of credit for the applicant’s

account. The first thing that should be done is the sales contract. The sales contract is

the formal agreement between the buyer and seller specifying the terms of sale that both

parties have agreed upon. The contract should include: a description of the goods; the

amount; the unit price; the terms of delivery; the time allowed for shipment and

presentation of documents; the currency; and the method of payment. Instead of it

partner can have only invoice, pro-forma invoice or even the order itself.

The bank's letter of credit application and agreement forms, when executed,

constitute a payment and reimbursement contract between the issuing bank and its

customer. It is also the customer's instruction to the issuing bank. The letter of credit

must be issued exactly in accordance with the customer's instructions; therefore, it is

important that the application be completed fully and accurately, so as to avoid the

inconvenience of having to have the letter of credit amended. The agreement constitutes

an undertaking by the customer to reimburse the issuing bank for drawings paid in

accordance with the terms of the letter of credit, and normally takes the form of an

authorization to debit the customer's account.

The issuing bank prepares the documentary credit as specified in the application

and forwards it by tele-transmission or airmail to the advising bank, (a branch or

correspondent of the issuing bank). The issuing bank instructs the advising bank as to

whether or not to add its confirmation, as per their customer's instructions.

35

The advising bank forwards the letter of credit to the beneficiary (seller) stating

that no commitment is conveyed on its part. However, if the advising bank has been

asked to confirm the letter of credit and agrees to do so, it will incorporate a clause

undertaking to honour the beneficiary's drafts, provided the documents evidence that all

terms and conditions of the letter of credit have been complied with.

Then the documents are sent to issuing/nominating bank for checking, after

which payment is usually made or eventually refusal of documents. Payment is being

made following the payment instructions of the beneficiary. After payment the

documentary credit transaction is considered to be over and necessary steps are being

made in the book keeping and internal procedure of the banks involved.

Figure 5 – Steps in an import documentary credit

Advice (confirmation) Application

Request to advise/

confirm l/c

6.2. Export/loro letter of credit

Upon receiving the letter of credit, the beneficiary should examine it carefully and be

satisfied that all the terms and conditions can be complied with. If this is not possible,

the beneficiary should request the applicant to arrange an amendment to the letter of

credit. Once completely satisfied, the beneficiary will then be in a position to assemble

and ship the goods.

The beneficiary prepares an invoice in the number of copies required, with the

description of goods shown exactly as stipulated in the letter of credit. The beneficiary

obtains the bill of lading and/or other transport documents from the carrier and prepares

and/or obtains all other documents required by the letter of credit. These are attached to

the draft, drawn on the bank indicated and at the term stipulated in the letter of credit,

and are presented to the advising/confirming/negotiating bank.

36

BUYERSELLER

ADVISING/CONFIRMING

BANK

ISSUING BANK

The advising/confirming/negotiating bank checks the documents presented by

the seller against the letter of credit. If the documents meet the requirements of the letter

of credit, that bank will send them to the issuing bank, claiming reimbursement and

paying the seller.

The issuing bank will also check the documents for compliance and then deliver

them to the applicant either against payment or as an undertaking to pay on maturity of

the drawing under the letter of credit.

Figure 6 – Steps in an export documentary credit

Goods

Documents Payment Delivers documents and debits acc.

Documents

Reimbursement

37

BUYERSELLER

ADVISING/CONFIRMING/NEGOTIATING

BANK

ISSUING BANK

7. DOCUMENTS USUALLY REQUIRED UNDER A LETTER OF CREDIT

There is no limit to the number and variety of documents that letters of credit may

stipulate. Each credit will require documents which are needed for a specific individual

transaction. The following is a list of documents most commonly seen in a letter of

credit transaction. Each document is described in brief with a checklist for preparing the

document. Documents must be presented at the nominated bank on or before the expiry

date within normal working hours. Period for presentation is period from the shipment

to the expiry date of the credit within which documents must be presented. If that period

is not stated it is considered to be 21 days.

As already stated, the beneficiary should, on first being advised of the letter of credit,

examine it carefully and be satisfied that all the documentary requirements can be

complied with. Unless the documentary requirements can be strictly complied with, the

beneficiary may not receive payment from the issuing bank. If there are any

requirements that cannot be complied with, the beneficiary should immediately request

the applicant to arrange for an appropriate amendment to the letter of credit. We have

seen that under the UCP 500 the parties involved in documentary credit transactions

deal with the documents. Banks do not take any responsibility as to the genuineness or

correctness of the documents received. If documents have apparent authenticity, for the

banks that will be enough not to reject documents because of forgery.

The documents presented under a documentary credit have to be originals unless

stated differently. Each required document must be in at least one original if there is no

stipulation saying that a document can be presented only in copy. When there is

wording in the credit requiring “one copy”, “one piece or copy”, it means that it calls

for at least one original of the required document. Originals are accepted instead of

copies if it not stated differently.23 A document written by hand with a pen or a

document written on a traditional typewriter is an original. If the document is being

copied it is often marked as original or if it is produced by automated systems. On their

surfaced it is usually stamped “original” or “duplicate”, “triplicate” etc. ICC banking

commission has issued its decision stating that if the documents are printed via PC it is

23 International Standard Banking Practice (ISBP), ICC Publication No. 645, 2003 Edition (supplement of the UCP 500 for the examination of documents under documentary credits)

38

considered as original appearing to be one. Also a photocopy with the issuer’s signature

is considered to be an original.

Regarding abbreviations, the use of generally accepted abbreviations (Ltd

instead of limited for instance) does not make a document discrepant. Corrections and

alterations of the documents must appear to be authenticated by the issuer. This

authentication must include issuer’s signature or initials. If it is authenticated by some

other party, it must clearly show in which capacity this third party has authenticated the

correction of the document. Each of those corrections on one document has to be

authenticated separately or one authentication must be linked with all the corrections in

an appropriate way. Drafts, transport documents and insurance documents must be

dated even if the credit itself does not require that. Dates may be expressed in a different

format. Documents presented under a credit must not be inconsistent with each other.

As far as signatures are concerned we have to say that drafts, certificates and

declarations by their nature require a signature. Transport and insurance documents

must also be signed in accordance with the UCP 500, the UCP 600 and their provisions.

If the document states that it is not valid without signature, than the signature is needed.

Signatures are accepted not only as handwritten, but also as facsimile signatures,

stamps, perforated signatures or any other electronic or mechanical authentication.

Under international standard banking practice, it is expected that documents

issued by the beneficiary will be in the language of the credit. In the conditions it can be

stated that other languages are accepted for all or for specific documents required by the

credit.24

7.1. Draft (bill of exchange or tenor bill)

A draft is a bill of exchange and a legally enforceable instrument which may be

regarded as the formal evidence of debt under a letter of credit. Drafts drawn at sight are

payable by the drawee on presentation. Term (usance) drafts, after acceptance by the

drawee, are payable on their indicated due date. The use of drafts is reduced nowadays

due to imposing the stamp duty (form of tax) by several countries (Italy for example). It

is more common to base payment undertaking on the credit rather than on bill of


39

exchange. The advantages of using drafts in connection with usance credit is that they

can be used for refinancing transferring them to other parties than those in credit.

Drafts need to have:

• Drafts must show the name of the issuing bank and the number and date of the letter

of credit under which they are drawn.

• Drafts must be drawn and signed by the beneficiary of the letter of credit.

• The terms of the draft must be expressed in accordance with the tenor shown in the

letter of credit; e.g., at sight or at a stated number of days after bill of lading/shipment

date.

• The amount in words and figures must correspond to the letter of credit and in the

same currency as the letter of credit.

• The amount must be in accordance with the total amount of the invoices unless the

letter of credit stipulates that drafts are to be drawn for a given percentage of the invoice

amount.

7.2. Commercial Invoice

The commercial invoice is an itemized account issued by the beneficiary and addressed

to the applicant, and must be supplied in the number of copies specified in the letter of

credit.

Invoice has to have:

• The invoice description of the goods must be identical to that stipulated in the letter

of credit.

• The invoice must be made out by the beneficiary of the credit and it should be

addressed to the applicant.

• Unit prices and shipping terms, i.e., CIF, FOB, etc., must be as stipulated in the letter

of credit. Extensions and totals should be checked for arithmetical correctness. If the

credit states shipping terms subject to INCOTERMS or other source of the trade term,

than it should be fully stated in an invoice (e.g. CIF Tokyo Incoterms 2000).

• An invoice need not to be dated or signed unless stipulated differently.

• An invoice must not show over-shipment and merchandise not asked in the credit

(including samples and advertising material).

40

• The quantity of the goods may vary +/-5% if it is not stipulated otherwise.25

7.3. Consular or Customs Invoice

A consular or customs invoice is prepared by the beneficiary on forms either supplied

by the buyer or local consulate offices. It is done on a special form available at the

embassy or consulate of the relevant country. The consular invoice is then to be

legalized by that embassy or consulate.

Requirements for the consular invoice are:

• Consular invoices must be visaed (officially stamped) and signed by a consular

officer of the importing country and be supplied in the official form and number of

copies as stipulated in the letter of credit.

• All headings of the forms must be completed.

• The value of goods required must agree with that shown on the commercial invoice.

7.4. Transport documents

Transport documents are one of the most problematic in the world of documentary

business. They are numerous and changeable over time, so it is hard to set some ground

rules for examining them. Transport field is changing rapidly and transport documents

take different forms and are subject to many changes. Transport documents usually are:

bill of lading, air waybill, road (CMR), rail or inland waterway transport documents.

Many articles of the UCP 500 and the UCP 600 deal with transport documents.

Transport documents can be divided into waybills (consignment notes) and negotiable

transport documents. Ocean bill of lading is an example of the negotiable transport

document as it gives title to the goods and the goods will be handed over to the named

person or company in the transport document (consignee). The consignee is actual

owner of the goods. Negotiable transport documents can be transferred to a new holder

or the ownership over the goods can be transferred. The transferring is done by

endorsing the document. Waybills do not provide access to the goods, but they state the

consignee. In the case of non negotiable transport documents, the issuing bank does not

have security in the goods.

Transport documents are issued by or on behalf of the carrier. Transport

document issued by a freight forwarder will be accepted if it is so stipulated in the credit 25 International Standard Banking Practice (ISBP), ICC Publication No. 645, 2003 Edition (supplement of the UCP 500 for the examination of documents under documentary credits)

41

or if freight forwarder acts as a carrier or his agent. Carrier actually deals with transport

issued and it is actual transporter of the goods, while the freight forwarder is only

intermediary arranging the transport. Carrier is the party responsible for the transport of

the goods.

The transport document has to be “clean” whether or not bears the notation

“clean on board”. It means that goods shipped on board are not defective or packaging

of the goods is not defective. If the documents bear no declaration or notation showing

defective goods or packaging it is considered to be “clean”.

Transport by sea is usually done in a container transport which protects the

goods. The container can be full or the goods can be placed with the goods of other

consignees. Code FCL means full container load and such container is to be loaded and

unloaded by parties other than the carrier. LCL means less than container load and in

this case the carrier is responsible for loading and unloading. Banks in general do not

pay attention to these codes, but transport document should not bear the clause “part

load” or similar clause meaning that the access to the goods is provided presenting all

other transport documents in connection with that container to the carrier. Banks will

also not accept a transport document showing that the goods are loaded on deck. Such

transport is very risky for the goods that can be easily damaged. Container can be

loaded on deck and this is allowed.26 Freight charges in the transport document have to

be consistent with the terms of the credit and with used trade terms such as Incoterms

2000. For example if the credit stipulates CIF trade terms it means that freight charges

have been paid already and the transport document in that case usually has notification

“freight prepaid. Otherwise, if it bears notification “freight payable at destination”, it is

discrepant. Here we will mention transport documents such as: bill of lading, air

waybill, rail consignment note (CIM), road consignment note (CMR), inland waterway

transport document, freight forwarder’s certificate and post and courier receipts.

7.4.1. Bill of Lading

A bill of lading is a receipt issued by a carrier for goods to be transported to a named

destination, which details the terms and conditions of transit. In the case of goods

shipped by sea, it is the document of title which controls the physical custody of the

goods. There are two different types of bill of lading:


42

• A STRAIGHT BILL OF LADING is one that names a specific consignee to whom

goods are to be delivered. It is a non-negotiable document.

• An ORDER BILL OF LADING is one that is written "to order" or to order of a

named party making the instrument negotiable by endorsement. Letters of credit usually

call for an order bill of lading blank endorsed, meaning the holder of the bill of lading

has title to the goods. Given that each bill of lading must be either "straight" or "order",

the following is a list of more common types of bill of lading:

• An OCEAN BILL OF LADING is one issued by an ocean carrier in sets, usually

three signed originals comprising a complete set, any one of which gives title to the

goods. It is usually covering port-to-port shipment. Ocean bills of lading may be issued

in "straight" or "order" form. If a credit calls for a “marine” or “ocean” bill of lading

Article 23 of the UCP 500 is applied. Transport document must indicate the number of

originals that have been issued.27 Name of the carrier must appear on the face of the bill

of lading and it must be identified as the carrier. If an agent signs a bill of lading on

behalf of a carrier, the agent must be identified as agent. Bill of lading usually has “on

board” notation meaning that the goods are placed on board the ship or intended vessel.

Date of “on board” notation will be deemed as date of shipment. “On board” notation

can take various forms such as “laden on board”, “clean on board”, or other similar

phrases which all mean the same. It is allowed for the bill of lading to have the field

“place of receipt” filled instead of “port of loading” when it is clear that the goods are to

be transported from the place of receipt by vessel and where is on board notation

evidencing the goods were loaded on that vessel. The similar rule applies for “place of

final destination” and “port of discharge”. If the credit requires a bill of lading to show

that the goods are to be consigned to the named party (a straight consignment), the bill

of lading must not contain words such as “to order of” or similar. If the credit stipulates

that the goods are to be consigned to the order of a named party than the bill of lading

must not show that the goods are consigned straight to the named party.28

27 Article23 of the ICC (International Chamber of Commerce in Paris) rules of the Uniform Customs and Practice for Documentary Credits, Publication No. 500 (the UCP 500)


43

• A SHORT FORM BILL OF LADING is one issued by a carrier which does not

indicate all the conditions of the contract of carriage. This is acceptable unless otherwise

specified in the letter of credit.

• A CHARTER PARTY BILL OF LADING is one which shippers may, when large

or bulk cargoes are concerned, lease the carrying vessel for a stated time or specific

voyage under a charter party contract with the owner. It is subject to the terms and

conditions of a charter party. Goods carried are then covered under a form of bill of

lading issued by the charterer and indicate as being shipped, subject to the term and

conditions of the charter party. Charter party bills of lading are not acceptable unless

specifically authorized by the letter of credit.

• A MULTIMODAL TRANSPORT DOCUMENT is one covering shipments by at

least two different modes of transport, one of which is typically by sea. It is also known

as “combined transport document”. The multimodal transport document is negotiable

document and full set has to be presented if not differently stipulated. Unlike the ocean

bill of lading, multimodal transport document need not to bear an on board notation.

Transshipment is of course accepted because it covers two different modes of transport,

no matter if it is not allowed in the credit conditions and if it covers the entire voyage.

Under the new UCP 600 multimodal transport document took the central role leaving

behind ocean bill of lading, because today this kind of transport is more and more

used.29

Transport documents should have the following characteristics:

• Ensure that the port of loading and port of discharge are as stipulated in the letter of

credit.

• The shipment must be consigned in the manner stipulated in the letter of credit.

• A general description of the goods is acceptable if consistent with but not necessarily

identical with the description specified in the letter of credit and other documents.

• If the letter of credit calls for an "on board" bill of lading, it must be evidenced by a

"shipped on board" bill of lading, or by marked or stamped "on board" notation

indicating the date the goods were loaded on board.


44

• If the letter of credit stipulates that freight is to be prepaid; or if the invoice is priced

CIF or CFR; or if the ocean freight has been added to the FOB or FAS value: the bill of

lading must be marked "freight paid" or "freight prepaid". Expressions such as "freight

to be paid" or "freight payable" are not acceptable.

• The bill of lading must be "clean". Any “dirty” clause indicating a defect in the

packaging or condition of the goods makes the bill of lading "unclean" and

unacceptable.

• Bills of lading indicating goods shipped "on deck" are not acceptable unless

specifically allowed in the letter of credit.

• The total number of packages comprising the shipment, shipping marks and

numbers, and any gross weight must agree with those on the commercial invoice and

other documents.

• Letters of credit should stipulate a period of time after date of issue of the bill of

lading or other shipping document for presentation of drawings. If no such period is

specified, banks will refuse documents if presented later than 21 days after the date of

"on board" endorsement, or, in the case of a shipped bill of lading or other shipping

document, 21 days after the date of issue.

• The bill of lading is to cover only goods described in the invoice and specified in the

letter of credit.

• Any correction or alteration must be initialed and authenticated by the party signing

the bill of lading.

• The name of the carrier must appear on the front of the bill of lading where the

particulars of the shipment are shown.

• If the bill of lading is signed by an agent, the name of the agent as well as the name

of the carrier must be shown.

45

Figure 7 – Sample of Bill of Lading

BILL OF LADINGTRAILER/CAR NUMBER: _________________ BILL DATE: __________________

FROM TO

Consignee:

Destination:

Street:

City State Zip:

Route:

SHIPPER‘S INSTRUCTIONS FOR PAYMENT, SEND BILL TO

DESCRIPTION OF COMMODITY

SPECIAL MARKS &EXCEPTIONS QUANTITY UNIT OF MEASURE US $ PAID LOT NUMBER CHARGES

Container/Trailer has been inspected and determined to be free of contaminants.Shipper Signature:

REMIT C.O.D. C.O.D. AMOUNT: $ C.O.D. FEECOLLECT PREPAID

TO:

ADDRESS:

If this shipment is to be delivered to the consignee without recourse on the consignor,the consignor shall sign the following statement: “The carrier shall not make deliveryof this shipment without payment of freight and all other lawful charges.”

______________________________________________________________________(Signature of Consignor)

TOTAL

CHARGES $

NOTE: Where the rate is dependent on value, shippers are required to state specifically in writing the agreed or declared value of the property. The agreed or declared value of the property is hereby specifically stated by the shipper to be not exceeding $

Freight Charges are collect unless marked prepaid.

CHECK BOX IF PREPAID

Shipper/Producer:

Origin:

Street:

City State Zip:

Special Instructions:

Name:

Company:

Street:

City State Zip:

46

RECEIVED subject to the classifications and tariffs in effect on the date of the issue of this Bill of Lading, the property described above in apparent good order, except as noted (contents and condition of packages unknown), marked consigned and destined as indicated above

which said carrier (the word carrier being understood through this contract as meaning any person or corporation in possession of the property under

the contract) agrees to carry to its usual place of delivery as said destination. If on its route, otherwise to deliver to another carrier on the route to

said destination. It is mutually agreed as to each carrier of all or any of said property, over all or any portion of said route to destination and as to

each party at any time interested in all or any said property, that every service to be performed hereunder shall be subject to all the Bill of Lading

terms and conditions in the governing classification on the date of shipment. Shipper hereby certifies that he or she is familiar with all the Bill of Lading terms and conditions in the governing classification and the said terms and conditions. This is to certify that the above

named materials are properly classified, described, packaged, marked and labeled and are in proper condition for transportation in accordance with all appropriate NOP organic standards and applicable regulation of the Department of Transportation.

Shipper/Producer Signature: Carrier Signature:

Per (Company): Per (Company):

7.4.2. Air Waybill

An air waybill is non-negotiable air transport document issued by an airline (carrier) or

its agent. It is a receipt issued by an air carrier indicating receipt of goods to be

transported by air and showing goods consigned to a named party.

Features of an Air Waybill should be:

• Only the goods invoiced and specified in the letter of credit may be covered by the

air waybill.

• The air waybill should be clean meaning that any clause evidencing defective state

of the goods or packaging is not acceptable.

• If the letter of credit stipulates that freight is to be prepaid; or if the invoice is priced

CIF or CFR; or if freight is otherwise included in the invoice: the air waybill must

indicate that freight has been paid.

• The airport of departure and airport of destination must be as stipulated in the letter

of credit.

• The number of packages and gross weight shown on the air waybill must be

consistent with the other documents.

• An air waybill issued by a forwarder is not acceptable.

47

Figure 8 – Sample of Air Waybill

Carbon copies attached:

BLUE - Original 1 - For Shipper

GREEN - Original 1 - For Issuing Carrier

WHITE - Invoice

WHITE - Remittance Copy

PINK - Original 2 - For Consignee

GOLDENROD - Delivery Receipt

WHITE - For Destination Agent's Copy

WHITE - Extra Copy

WHITE - Extra Copy

WHITE - Extra Copy

48

7.4.3. Rail consignment note (CIM)

CIM is used when the goods is transported by rail. It is issued by railway company. A

rail consignment note evidences that the goods are received by a railway company for

transport.

The rules regarding CIM are more or less very similar to the rules applying for other

transport documents so we will just briefly mention some of the things that should be

incorporated.

It should have:

• The name of the carrier, signed and issued by the carrier or his agent

• It must indicate the place of shipment and the place of destination as stipulated in the

credit

Figure 9 – Sample of CIM

49

7.4.4. Road consignment note (CMR)

It is also issued by a carrier and it is used for a transport by truck evidencing that the

goods is received by carrier for transport. The date of the issuance will be deemed as the

date of shipment, unless there is a reception stamp. Concerning rules on how a CMR

should look like they are almost identical to other transport document, especially a CIM.

One thing that should be mentioned is that a CMR is issued in the language of the

50

country where it is being issued and that is accepted if a CMR has explanation of all the

fields in the language of the credit.

Figure 10 - Sample of CMR

7.4.5. Inland waterway transport document

It is used for river transport as a non-negotiable document very similar to other transport

documents concerning applicable rules described in the Article 28 of the UCP 500.

7.4.6. Freight forwarder’s certificate

As we have already said transport documents should be signed by a carrier, but it is

allowed to have documents issued by a forwarder if a credit allows it. The International

51

Federation of Freight Forwarders’ Associations (FIATA) has its own document referred

to as Negotiable FIATA Multimodal Transport Bill of Lading (FBL). It usually shows

that a forwarder acts as carrier and as such it can be used in documentary credit

transactions (even if credit does not stipulate its use). Any other freight forwarder’s

document will also be accepted if it is evidencing that a forwarder acts as carrier.

7.4.7. Post and courier receipts

They are used for goods limited in volume and weight. Post receipt is issued by a post

office, while a courier receipt is issued by the relevant courier service. They are

evidencing receipt of the goods for dispatch. Both of them must be properly stamped

bearing pick-up dates which are considered to be the dates of the dispatch.

7.5. Other documents

Other documents presented and explained here are first of all in connection with the

insurance. Then, we will see documents issued for the customs authority or documents

needed for tax exemption. At the end there are documents wanted by an applicant for

various reasons.

7.5.1. Insurance Policy or Certificate

Under the terms of a CIF contract, the beneficiary is obliged to arrange insurance and

furnish the buyer with the appropriate insurance policy or certificate. The extent of

coverage and risks should be agreed upon between the buyer and seller in their initial

negotiations and be set out in the sales contract.

Since the topic of marine insurance is extremely specialized and with conditions

varying from country to country, the services of a competent marine insurance broker

are useful and well-advised. Some banks will not issue a credit if the goods are not

insured because they want a security for the goods. Those banks will demand applicant

to present insurance coverage in case that beneficiary is not obliged to insure the goods.

What one Insurance policy or certificate generally ahs to fulfill:

• If the letter of credit calls for an insurance policy, an insurance certificate is not

acceptable and the policy must be provided. Broker's cover notes are not acceptable

unless specifically allowed in the letter of credit.

• If the insurance policy or certificate indicates that it is issued in duplicate, both

copies must be presented.

52

• Unless the amount to be insured is stipulated in the letter of credit, the amount

should cover at least the CIF value plus 10 percent if invoiced in those terms.

Otherwise, the amount should be for the greater of the draft amount or the total invoice

value plus 10%.

• The amount insured must be expressed in the same currency as the letter of credit.

• The description of the goods insured must be consistent with that in the other

documents although not necessarily identical.

• The number of packages comprising the shipment and shipping marks and numbers

must agree with those shown on the invoice and bill of lading.

• The name of the carrying vessel, port of loading and port of discharge must agree

with those shown on the bill of lading.

• The insurance document must cover transshipment if transshipment is indicated on

the bill of lading.

• The insurance document must cover specifically those risks stipulated in the letter of

credit. The "all risks" clause in the insurance document does not cover risks of war,

which must be separately shown as covered, if required by the letter of credit.

• Unless the letter of credit specifies to whom loss is to be payable, the insurance

document must be endorsed by the party to whose order it is made so as to be in

negotiable form.

• The date of the insurance document should not be later than the date of shipment as

shown by the bill of lading or other transport document. However, the insurance

document may be dated after the date of shipment provided it evidences that cover is

effective from date of dispatch i.e., by way of "warehouse to warehouse" clause.

• Any alterations or corrections to the insurance document must be initialed by the

party signing the document.

• The insurance document must be signed by an authorized person.

• The foregoing are the most common documents usually called for in an export letter

of credit. The following may also be asked for to satisfy government requirements or for

the convenience of the buyer.

7.5.2. Certificate of Origin

As the name suggests, a certificate of origin certifies as to the country of origin of the

goods described and should comply with any stipulations in the letter of credit as to

53

originating country and by whom the certificate is to be issued. The certificate should be

consistent with and identified with the other shipping documents by shipping marks and

numbers, and must be signed and dated. A certificate of origin is often issued by a

chamber of commerce, the customs authorities or other body authorized for making it. It

must appear to relate to the goods from the invoice.30

7.5.3. GSP certificate (GSP: Generalized System of Preferences)

GSP certificate is based on Generalized System of Preferences established by UNCTAD

and it is issued to allow the use of the scheme for customs preferences. This certificate

is issued by the exporter who certifies that the goods have been manufactured in the

relevant country. It also evidence that export of the goods to the importing country are

in compliance with the rules on the “generalized system of preferences for goods”. The

document must be signed by the authorities of the exporting country as well.

7.5.4. Movement certificate (EUR)

It is introduced as a result of a trade agreement between the EU and certain non EU

countries. Those countries enjoy a tariff preference or a customs relief when exporting

goods to the EU. EUR certificate is issued by customs authorities or exporter if it is

authorized by customs authorities. There are various forms of the EUR certificate

depending on the value of the goods (EUR 1, EUR 2 etc.). It is usually issued only in

the language of the relevant country so this should be taken into account when

stipulating a documentary credit.

7.5.5. Import and export licenses

Some countries have strict control of import or export for various reasons. For some it is

the way to control the types of goods importing or exporting from the country. Certain

type of goods can be exposed to such regime of licenses. There can also be a limit for

export or import of certain type of goods.

7.5.6. Health or phyto-sanitary certificate

Health certificate shows health and sanitary conditions of the goods. Often it is issued

by a veterinary, veterinary authorities or ministry of agriculture. Some countries for

some type of goods require this kind of certificate for importing that kind of goods.


54

Phyto-sanitary certificate is used for import of live plants. The applicant may stipulate

or require these certificates even for their own control to ensure that the goods are in

good condition.

7.5.7. Inspection Certificate

When a letter of credit calls for an inspection certificate it will usually specify by whom

the certificate is to be issued; otherwise, the same general comments as in the case of

the certificate of origin apply.

As a preventative measure against fraud or as a means of protecting the buyer

against the possibility of receiving unwanted or defective goods, survey or inspection

certificates issued by a reputable third party may be deemed as efficient. Such

certificates indicate that the goods have been examined and found to be as ordered. The

applicant itself can send its representative to inspect the goods, but sometimes it can

inefficient and expensive. There are some recognized international companies, such as

Societe Generale Surveillance (SGS) in Switzerland which is dealing with inspection.

The applicant in this case will instruct the inspection company to perform an inspection

issuing the inspection certificate.

7.5.8. Packing List

A packing list is usually requested by the buyer to assist in identifying the contents of

each package or container. It must show the shipping marks and number of each

package. It can show the net and gross weight of the goods. It is not usually required to

be signed. Weight list or certificate can be accepted instead of the packing list if they

have all needed data.

7.5.9. Quality certificate

Sometime the applicant wants a declaration regarding the quality of the goods. Such

document is typically issued by a beneficiary or by a producer. It has to be signed by the

issuer and contain data as stipulated in the credit.

7.5.10. Warranty

If a warranty has been agreed between the seller and the buyer, than this document has

to be presented together with other documents. It is normally issued by the producer or

55

the beneficiary and it serves to establish the liability of the issuer towards the buyer

under the sales contract or other agreement as to the goods sold.

7.5.11. Shipping company’s declaration

The applicant may demand for several reasons that the goods are not to be shipped by a

certain type of vessel or not going into countries and ports not wanted by the applicant.

This declaration is issued by a carrier. For example it may be demanded for a vessel not

to be older than a certain number of years for safety reasons or that the vessel should not

enter some ports and countries for a reason of embargo or political instability, wars etc.

56

8. PRESENTATION OF DOCUMENTS

Presentation of documents is an important step in a documentary business. Here we will

explain some steps after the presentation of documents such as honouring, examining,

discrepancies in documents and refusal of the documents.

8.1. Honouring documents under documentary credit

Honouring the documents means that after examining the documents presented by the

beneficiary, the relevant bank will honour the documents if they are conforming to the

terms and conditions of the credit. Actually the relevant bank will “release” the

documents thus saying the documents will be paid upon the maturity. Apart from the

presenting documents, they have to be presented in the place and in due time to the bank

authorized to honour the documents (nominated bank). The beneficiary may, according

to the UCP 500 and the UCP 600, present the documents either in the nominated bank

or direct to the issuing bank. Documents must be presented within the expiry date of the

credit and within allowed period for presentation of documents often being 21 days. If

the place of expiry is in the beneficiary’s country this means that the documents should

be sent at the latest on the date of expiry by the beneficiary’s bank (this date is the date

on the covering letter of the beneficiary’s bank). If the place of expiry is in applicant’s

country, the documents should reach issuing or the nominated bank by the date of

expiry (if it is Saturday or if the nominated bank is closed on that day, this period is

prolonged to the next working day). Documents must never be presented after the date

of expiry whatever is the period for presentation. After the honouring of documents, the

nominated bank will inform the beneficiary that it will make payment if the credit is

confirmed by it. If the credit is not confirmed the nominated bank will inform the

beneficiary that it will settle the amount after receiving the funds from the issuing bank.

The nominated bank can finance the documents by paying the beneficiary before it has

received the funds from the issuing bank.

8.2. Examination of documents

As we have seen the relevant bank will check the documents upon their presentation.

Checking the documents is being done in compliance with all the rules for which the

credit is subject to. Today almost all banks use and stipulate ICC UCP rules for

examining documents. The banks will check the documents whether they appear on

57

their face to be in conformity with the terms and conditions of the credit as they deal

with the documents and not with the goods. The banks will examine documents

stipulated in the credit, without examining other documents which can be returned to

the sender. All the data in the documents should be consistent with one another. Data in

one document such as Certificate of Origin for instance, should not be inconsistent with

the data in any other document presented. Sometimes there are requirements or

stipulations in the credit that are specific, but not calling for any specific document to be

presented (e.g. the goods must be of polish origin). That creates confusion and it is hard

to satisfy some of those conditions if there is no specific document stipulated. Article 13

c in the UCP 500 states that: “If a credit contains conditions without stating the

documents(s) to be presented in compliance therewith, banks will deem such conditions

as not stated and will disregard them.”31

We should mention two basic principles applied when it comes to examining of

the documents presented. Those two principles are substantial compliance and strict

compliance. Concept of the substantial compliance means that it is essential that the

goods in order reaches the buyer, that prices and periods are as stipulated, rather than

that all the documents must be precise. The problem is to determine form bank to bank

what is reasonable and what are things that have to be considered while examining and

that is why this principle nowadays is more theory than practice. Principle of strict

compliance means that all conditions and details must be in strict compliance with the

credit and international rules and that all documents must be consistent with one

another. Strict compliance should not be understood literally and there are rules

regarding the types of errors or other details that are explaining what is acceptable.

When the nominated or the issuing bank receives the documents it has some

time limits for examining them established by international rules. Firstly it was set by

international rules that period for handling and examining documents should be done in

“reasonable time”. Such not precise term caused many different interpretations. At the

end it was inserted in the UCP 500 that this period should not exceed seven banking

days following the day of receipt of the documents. Some banks take this for granted

and effect payment under credits after 7 banking days, not taking into consideration

31 Article13 c of the ICC (International Chamber of Commerce in Paris) rules of the Uniform Customs and Practice for Documentary Credits, Publication No. 500 (the UCP 500)

58

“reasonable time”. That is misinterpretation of this rule because the “reasonable time”

depends on many factors such as complexity of the credit, the number and size of the

documents and some specific things concerning the relevant bank in question. This time

should be enough for the issuing bank to obtain waiver of discrepancies from the

applicant in case of discrepancies noted in credit. Under the new UCP 600 (taking into

force as from 01. July 2007) this time limit was reduced to 5 banking days and that is

probably the main difference with the UCP 500.32 If not fulfilled by the issuing or

confirming bank this rule will cause that those bank cannot refuse the documents and

must effect the payment under the credit. The nominated bank which has not confirmed

the credit is obliged to follow this rule also, but it is not obliged to pay as it has not

assumed payment undertaking.

8.3. Discrepancies in the presented documents

There are many reasons for presenting discrepant or the documents not complying with

the credit terms and conditions. International banks have estimated that around 70% of

the sets of documents presented are with discrepancies. One of the reasons is not clear

agreement between the seller and the buyer or absence of that agreement which leads to

discrepancies in the documents presented. The beneficiary should check the credit

received in order to see if it is possible for him to meet all the requirements. If that is

not the case he should ask for an amendment of the credit. Sometimes it happens that

the applicant does not arrange for the amendment for various reasons. Usually the

beneficiary fails to send proper documents because of the lack of knowledge on the

documentary credits and the international rules applying to it. The beneficiary has the

possibility to correct the documents if there is time for it. The usual discrepancies

showing in the documents are : period for presentation and/or date of expiry are

exceeded, the amount of credit over the limits or not fully utilized, dispatch from a place

other than stipulated in the credit, description of goods inconsistent, the bill of lading

does not have notation “on board”, carrier is not indicated in the transport document,

transshipment or partial shipment are made in case they are not allowed by the credit,

the insurance documents contains a date later than the date of shipment, the insurance


59

policy does not contain stipulated risks and does not cover 110% of CIF or CIP value

etc.

If the documents received have severe discrepancies and the issuing bank (or the

applicant) is not ready to accept them, the best option is to send the documents back to

the beneficiary. After that the beneficiary may redirect the goods to himself or to

another buyer.

IF the documents cannot be corrected the nominated bank may, according to the

agreement with the beneficiary, send a request (usually by S.W.I.F.T.) to the issuing

bank asking it to accept the documents despite discrepancies described. The issuing

bank will probably leave this decision to be made by the applicant. If none of this is an

option the beneficiary will forward the documents through a nominated bank to the

issuing bank which is most common. This way the issuing bank will have to take up the

documents (release or honour them) or to refuse documents. There is one disagreement

between banks in regard to receiving the documents after expiry date. One consider that

the credit does not exist in this case and that presentation is to be considered a

documentary collection and the other consider late presentation as a discrepancy under

that credit. If the documents are lost in transit none of the banks has the obligation to

pay. Payment to the beneficiary at the earliest can be expected if the beneficiary bank is

willing to pay after the message of the issuing bank saying that the documents are taken

up and that the issuing bank is ready to pay despite discrepancies. The applicant cannot

take possession over the documents in case he did not approved the discrepancies and

this means he cannot take over the goods and have them cleared through the customs.

8.4. Refusal of documents

First of all we must add that a documentary credit is an instrument of payment and as

such should serve to that purpose. Only in few cases documents are refused with non-

payment as a result and this is proof that documentary credit is really an instrument of

payment. Reasons for refusing documents may be different. If the discrepancies in the

documents are such that reduce applicant’s possibility to take over the goods or weaken

his position in this transaction, then the refusal of documents is understandable. There

are some example of such cases: if the importer of Christmas decoration receives the

goods later than it is stipulated by the credit it is a good ground for refusal because it is

not possible for him to sell decoration after Christmas or wrong spare parts sent (wrong

60

specification and description of the goods) for a machine used by the applicant for

production. Reasons for refusal in practice can be any defection in the goods, case

where market price has fallen causing not probable future cooperation between the

buyer and the seller (although the reason stated is discrepant documents), the applicant

may not want the goods changing his mind, the applicant wants unreasonable reduction

in price or the applicant just cannot pay (the issuing bank will usually refuse the

documents based on discrepancies if the applicant has gone bankrupt).

Under UCP rules the issuing bank may approach to the applicant for a waiver of

discrepancies, but at the end it is up to the issuing bank to decide about it. The issuing

bank must take the decision and notify the presenting bank or the beneficiary within

prescribed time limits (within reasonable time not exceeding 7 or 5 banking days

depending on the rules applied in the specific case). Although this is possible, the

issuing bank will seldom take the decision opposite to the applicant’s instructions. This

rule is in accordance with UCP rules, because the issuing bank is the one taking

separate payment undertaking and the applicant takes no part from a documentary credit

point of view and the rules applied. The notification of refusal must be done

immediately by telecommunication means (in majority of cases by S.W.I.F.T.). The

beneficiary has the right to present corrected documents within the expiry date and

within the period for presentation after notification of refusal by the issuing bank. The

discrepancies because of which documents are refused must be stated by the issuing

bank and it is not possible to add other reasons for refusal afterwards.

Refusal of documents means that no payment will be made under letter of credit.

Seller can lodge a claim only using sales contract as a base for the claim. In case where

the nominated bank has found no discrepancies and paid to the beneficiary, there is no

difference between confirmed and unconfirmed credit. In this case risk of non-payment

by the issuing bank falls on the nominated bank and not on the beneficiary. In other

cases the risk falls on the beneficiary, but if the issuing bank has contributed to the

goods being handed over to the applicant, than the issuing bank bears a risk and has to

reimburse the beneficiary. The beneficiary has to take prompt action as to the goods in

stake in order not to have them sold by customs authorities. He has to redirect the goods

to another buyer, store them somewhere or return them.

61

8.5. Guidelines for dishonouring the documents

When documents are presented by the beneficiary and are found not to be in accordance

with the terms of the letter of credit, the following courses of action are available:

• The documents may be corrected if possible. However, this option is only applicable

if the discrepancies are such that the beneficiary, shipping company or whoever is

concerned is able to correct the discrepancies before the expiry of the letter of credit and

within the period of time allowed for presentation of the documents.

• If the discrepancies cannot be corrected, the beneficiary's bank may request authority

from the issuing bank to negotiate the draft, despite the discrepancies.

• If, in the case of a sight draft, the beneficiary wishes to receive the proceeds of the

drawing immediately, then an indemnity may be the expedient method. Under the

indemnity the beneficiary agrees to indemnify the negotiating bank for payment of

principal, interest and any other loss resulting from the refusal of the issuing bank to

honour the drawing due to non-conformity of the documents. If the discrepancies are

considered minor, the beneficiary's bank may be prepared to negotiate the draft "under

reserve"; it being understood the beneficiary's bank will have recourse to the beneficiary

if the discrepancies are unacceptable to the issuing bank.

• As a last resort, documents may be sent to the issuing bank on an "approval" basis;

the documents to be delivered to the buyer only against the buyer's authority to pay or

accept.

62

9. SOLVING DISPUTES AND FRAUDS IN DOCUMENTARY BUSINESS

9.1. Courts decisions, arbitration and expert decisions

Relatively very small number of documentary credits is disputed and even less of

disputes under them are settled through the court. The trials take a long time and can be

very expensive, and banks avoid having them. Usually only if there are severe disputes

for big amounts are going into courts. In the UCP it is not said which country’s law is

applicable and it is usually the law of the country where the credit is available i.e. where

the documents are presented. The courts will in majority of cases base its decision on

international rules and on the ICC opinions. The courts can call technical experts to

expose their opinions as to the credit disputed. Problem with some cases is that lawyers

and judges in charge do not have satisfactory knowledge on documentary credits and

their decisions can provoke confusion among the banks and people dealing with

documentary credits.

Instead of going into court, the parties involved may choose to go for arbitration.

There are several international institutions that can do arbitration. ICC International

Court of Arbitration in Paris is among most important and it is often used for

arbitration. The advantage of arbitration comparing to an ordinary court is that both

parties can appoint experts on the issue to make a decision together with the arbitrator.

Another advantage is that arbitration decisions are not published.

The parties disputing about a documentary credit can have a documentary credit

expert, as an objective third party, to settle the dispute. The problem with expert

decision is that the decision is binding only in case of agreement to respect the decision

between both parties. There is one body under the ICC, Centre for Expertise that is

providing such service.

9.2. Fraud and forgery

Since we mentioned earlier that banks deal with documents and not with the goods

presented in those documents, this gives possibility for fraud and presenting forged

documents. In practice fraud is very rare. Because the fraud and forgery is not covered

by the UCP rules, each case is subject to the national law of the country in question and

judicial decision are very different among the different countries. The nominated bank

has the right to refuse to pay if it detects fraud and forgery. Stopping the payment under

63

fraud and forgery can be done if fraud and forgery are documented and if existed before

the credit is honoured. The ICC has established a special unit in London, the ICC

International Maritime Bureau (IMB) which deals with investigations of this type of

crime.

The best way to prevent fraud is to “know your customer”. The typical situation

of a fraud in documentary business is when beneficiary/fraudulent seller offers supply

of big quantities in order to obtain a big amount of money. He offers goods usually at a

significantly lower price and the goods is often bulk goods such as sugar, cement or

similar. The aim is to cause the interested buyer to ask for the issuance of the letter of

credit which can be confirmed by a recognized bank. To collect that amount the

fraudulent seller presents forged documents and disappears. There is another situation

where the buyer and the seller try together to deceive the bank involved where buyer

approves the documents containing specific discrepancy directly to the seller. After this

nominated bank can pay the amount of credit to the seller and then the buyer does not

approve the documents after all, but the beneficiary has disappeared or gone bankrupt in

the meantime.

There are also cases where a beneficiary receives a documentary credit that turns

out to be forged and not genuine, because it was not issued by the issuing bank stated in

the credit. A beneficiary in this case should contact his own bank that will determine the

authenticity of such a credit.

64

10. A BRIEF EXPLANATION OF TRADE TERMS

Trade terms are defined in great detail in a publication of the International Chamber of

Commerce entitled Incoterms.33 Explanations of four of the most common terms are:

CFR: "Cost and Freight" to the named port of destination. The seller loads the goods on

board the carrying vessel at his expense, prepays the freight and supplies the buyer with

a "clean" negotiable "on board" ocean bill of lading. Insurance of the goods is the

buyer's responsibility.

CIF: "Cost, Insurance and Freight" to the named port of destination. The seller loads

the goods on board at the port of shipment at his expense, prepays the freight and cost

of marine insurance and supplies the buyer with a negotiable marine insurance policy

and a "clean" negotiable, "on board" ocean bill of lading.

FOB: "Free On Board" to the named port of shipment. The seller delivers the goods on

board the carrying vessel and bears all costs and risks until goods pass over the ship's

rail. The seller supplies the buyer with a "clean" negotiable "on board" bill of lading.

The buyer is responsible for payment of freight and insurance.

FAS: "Free Alongside Ship". The seller delivers the goods alongside the vessel at the

loading Berth named by the buyer. At this point the seller's obligations are fulfilled.

This means the buyer bears all costs and risks of loss or damage to the goods from that

moment. Unlike FOB, this term requires the buyer to clear the goods for export and pay

loading costs in addition to freight and insurance.

33 Incoterms 2000, ICC Official Rules for the Interpretation of Trade Terms ICC Publication No. 560, 2000 Edition

65

11. PARTIES INVOLVED IN A DOCUMENTARY CREDIT TRANSACTION

In order to help the reader understand the steps taken in a letter of credit transaction, the

following is a brief description of the parties most commonly involved in letters of

credit:

Accepting Bank - The bank named in a letter of credit on whom term drafts are drawn

and who indicates acceptance of the draft by dating and signing across its face, thereby

incurring a legal obligation to pay the amount of the draft at maturity.

Advising Bank - A branch or correspondent bank at or near the domicile of the

beneficiary, to which the issuing bank either sends the letter of credit, or a notification

that a letter of credit has been issued, with instructions to notify the beneficiary. The

advising bank advises the beneficiary of the letter of credit without engagement.

Nominated bank - A bank authorized by the issuing bank to honour the documents on

its behalf

Applicant - The buyer or the party who requests the letter of credit to be issued.

Beneficiary - The seller or the party to whom the letter of credit is addressed.

Confirming Bank - A bank usually in the country of the beneficiary which, at the

request of the issuing bank, joins that bank in undertaking to honour drawings made by

the beneficiary, provided the terms and conditions of the letter of credit have been

complied with.

Discounting Bank - A bank which discounts a draft for the beneficiary after it has been

accepted by an accepting bank.

Drawee Bank - The bank named in the letter of credit on which drafts are to be drawn.

Drawer - The beneficiary of the letter of credit who will draw the draft in accordance

with the terms of the letter of credit.

Issuing Bank - The bank which opens a letter of credit on behalf of the applicant and

forwards it to the advising bank for delivery to the beneficiary.

Negotiating Bank - Usually the beneficiary's bank which, after satisfying itself that the

documents conform with the letter of credit, agrees to purchase the draft (pay the

beneficiary).

Paying Bank - The bank named in the letter of credit where drafts are to be paid. It is

not necessarily the issuing bank, but often a branch of the issuing bank or its

66

correspondent. Once drafts have been paid or accepted by the paying/drawee bank, there

is no recourse to the drawers.

Reimbursing Bank - The bank authorized by the issuing bank to reimburse the drawee

bank or other banks submitting claims under the letter of credit.

Forwarding Agent – The person or a company arranging transport on behalf of the

seller

67

LITERATURE AND SOURCES:

1. ICC (International Chamber of Commerce in Paris) rules of the Uniform Customs

and Practice for Documentary Credits, Publication No. 500 (the UCP 500)

2. www.swift.com – S.W.I.F.T. (Society for Worldwide Interbank Financial

Telecommunication)

3. ICC Guide to Documentary Credit Operations for the UCP 500, Charles del Busto,

ICC Publication No. 515, 1994 Edition

4. ICC (International Chamber of Commerce in Paris) rules of the Uniform Customs

and Practice for Documentary Credits, Publication No. 600 (the UCP 600)

5. Documentary Credits in practice; Reinhard Langerich; First Edition 2000.

6. www.iccwbo.org - International Chamber of Commerce (ICC) – The world

business organization

7. Incoterms 2000, ICC Official Rules for the Interpretation of Trade Terms ICC

Publication No. 560, 2000 Edition

8. International Standard Banking Practice (ISBP), ICC Publication No.

645, 2003 Edition (supplement of the UCP 500 for the examination of documents

under documentary credits)

68

http://www.iccwbo.org/
