|
Letter of credit (L/c) is a widely
accepted and commonly used payment method in international
trade. They are usually issued by larger banks
and contain a promise to pay a seller (beneficiary)
upon receipt of goods by a buyer if certain conditions
outlined in the letter have been met.
There are three general principles
governing the use of letters of credit:
-
The banks' responsibility to
deal in documents only;
-
the rule of strict construction,
which dictates that the terms and conditions
of the letter of credit are to strictly adhered
to; and
-
the rule of independence, which
mandates that the letter of credit is to be
considered independent from the sales contract
or any other agreement between the parties.
Put simply, the Issuing bank has
two main roles:
-
To give a binding undertaking
to the seller that if compliant documents
are presented, the bank will pay the seller
the amount due. This offers security to the
seller
-
To examine the documents, and
only pay if these comply with the terms and
conditions set out in the letter of credit.
This protects the buyer's interests
Note that the letter of credit
refers to documents representing the goods - not
the goods themselves! Banks are not in the business
of examining goods on behalf of their customers.
Typically the documents requested will include
a commercial invoice, a transport document such
as a bill of lading or airway bill, an insurance
document; but there are many others.
How secure is the L/c payment method
? Although an L/c is considered one of the most
secure means of payment, exporters should understand
that they can never totally control the payment
process. Documents which are required to be presented
under an L/c are frequently prepared by other
people, and may not meet the strict compliance
standards required by the banking community for
payment. Sometimes banks which have not properly
ensured their own reimbursement by customer (the
buyer), apply very narrowly L/c principles to
deny payment. Such denials have regularly been
upheld by courts on grounds that the seller has
not strictly complied with the terms of the L/c.
How
to Secure your Payment ?
Like most other things in life
-prudence, knowledge and certain precautions can
greatly reduce your risk. Following are certain
steps that an exporter can take to maximize his
control of the L/c process
Knowledge
is Power
The rules governing L/c are codified
in a publication sponsored by the International
Chamber of Commerce ("ICC"), known as the Uniform
Customs and Practice for Documentary Credits.
Professionals advising exporters should have a
good understanding of the UCP 500. The rules in
the UCP 500 are drafted by and for the banking
community. One of the major purposes is to protect
the banks from liability in L/c transactions.
The banks are providing a service - the financing
of the transaction - and they expect to be protected
from getting involved in disputes between the
parties as to the terms of the contract of sale.
For this reason "the independence principle" is
a very important concept in LC transactions. This
means that the LC, and the documents required
under the LC for payment, are completely independent
from the underlying transaction between buyer
and seller.
The bank is not concerned if the
contract between buyer and seller is being performed
according to its terms. The bank's only concern
is whether the documents presented by the seller
conform to the documents required under the LC,
and whether the documents are presented within
the required time periods. The bank employees
who examine documents presented under the L/c
are essentially clerks. Their job is not to make
judgment calls, but simply to see if the documents
presented by the seller/ beneficiary comply strictly
with the documents required by the LC. It is therefore
very important to understand the rules as a lack
of knowledge may invite disaster.
Your
choice of Issuing Bank
One way of securing some control
on payment process is to choose a bank you know
or familiar with. This implies that during negotiating
seller should try to get the buyer to use a bank
of the seller's choice to issue the L/c. The seller
should find out from his/her own bank, preferably
a bank with a substantial international presence,
what corresponding bank it uses in the country
of the buyer. If the buyer can have the L/c issued
by that correspondent bank, the process can proceed
more expeditiously. At the very least, the seller
should insist that the buyer use a bank that is
well-known and highly regarded by the banking
community. The seller's own bank can provide information
on the financial status and reputation of the
foreign bank. Since a major purpose served by
an L/c is that the issuing bank assumes the risk
of the buyer's insolvency, if the bank itself
is financially weak, the L/c may not serve its
purpose.
When
in doubt - Get Confirmation
If the seller is not comfortable
with the bank of the buyer's choice, the L/c should
be confirmed by a prime world bank. When a prime
bank confirms an L/c issued by a foreign bank,
it takes upon itself the payment obligation. There
is a charge for confirmation, which varies directly
on perceived risk the prime bank believes it is
taking in confirming the L/c. The question of
who pays the prime bank's confirmation charges
is negotiable, but if not negotiated in advance
the bank may charge the beneficiary.
Simple
Documentation
The seller should ensure during
negotiation that as few documents as possible
are submitted to bank, that documents should have
simple description and all documents called for
by the L/c can in fact be produced. Seller should
avoid dependence on unknown or unreliable parties
(e..g. if bank documents include a certificate
from the government of buyer's country or a signature
from someone under buyer's control - complications
may arise).
Accuracy
of Wording
Accuracy of wording in respect
of all documents to be submitted in bank is vital.
For example, almost all L/c's require production
of a commercial invoice and a transport bill of
lading. The invoice must state the description
of goods in the same way as in L/c. If the goods
are not described in exactly the same way, the
seller may not be paid even though Bill of Lading
may have correct wording.
Be
sure what you are doing
If seller realizes there is a mistake
or a problem with the documents to be submitted
in bank, the goods should not be shipped until
the L/c is amended. The UCP 500 makes clear that
no amendment can take place unless the issuing
bank, the confirming bank, if any, and the seller,
agree to it. Unless the seller has written confirmation
from the bank that the amendment to the L/c has
been issued, and the confirming bank has accepted
the amendment, he bears the risk of not being
paid.
A
stitch in time..
A prudent seller should not let
buyer take possession of goods until he has been
paid under the L/c. The reason is obvious - if
there are discrepancies in the documents preventing
payment of the L/c, a buyer in possession of the
goods has much less incentive to waive discrepancies
so the seller can be paid. If the seller is not
paid by the bank, the buyer still has a contractual
obligation to pay for goods, but the difficulty
of collection can make the price drop substantially,
even assuming the buyer is solvent and can pay
something. Particularly when the goods have been
shipped to a foreign country, the payment collection
can be quite costly. The buyer, knowing this,
may attempt to negotiate a lower price (that is
if he pays at all).
To keep goods out of the buyer's
possession till payment is settled, the seller
should have the bill of lading consigned to order
of the bank. Since the bill of lading is a title
document, a consignment to order of the bank gives
the bank title to the goods until they have been
paid for by the buyer. Assuming proper payment,
the bank transfers title to the buyer, who can
then take the bill of lading and collect the goods.
If buyer does not pay, the bank has an obligation
to hold the documents for the seller, or return
them to the seller if instructed to do so by the
seller. The buyer should not be able to get the
goods without the title document.
Look
Before you Leap...
The buyer may ask seller to have
the bill of lading made out to order and blank
endorsed, and to send one or more sets to the
buyer within a few days of shipping the goods.
This is like writing a blank check. It enables
the buyer to pick up the goods, and thereby provides
him with a disincentive to waive any discrepancies
in documents the seller presents to the bank.
Given the high failure rate of initial presentations
of documents under an L/c, a seller needs to know
he will have the buyer's cooperation in correcting
discrepancies or in waiving them. The buyer's
cooperation will be more forthcoming if he cannot
get possession of the goods until any problems
with discrepancies have been resolved.
Know
Your Deadline, for your sake...
Every L/c has three vital dates:
the date by which goods must be shipped, the date
by which documents must be presented, and the
expiry date for the L/c. A seller should make
sure that each of these dates can be met, and
should allow a large margin for error. After the
L/c has been issued, if the seller learns that
the date for shipping goods cannot be met, he
should not ship any goods until he obtains an
amendment to the L/c permitting later shipment.
If an L/c which calls for transport
documents does not contain a date by which documents
must be presented, does this mean the seller can
wait until the expiry date to present his documents?
Not if he wants to be paid. Article 43 of the
UCP 500 provides that if no time period after
shipment is given in the Credit for presentation
of documents, banks will not accept documents
presented to them later than 21 days after shipment.
An exporter unfamiliar with the 21 day rule of
the UCP 500 could easily miss this deadline.
The exporter should make sure that
the expiry date of the L/c permits sufficient
time to permit correction, if possible, of any
mistakes in the documents. Under the UCP 500,
once the documents are presented, the bank has
a maximum of seven days to let the beneficiary
know if there are any discrepancies. If discrepancies
can be corrected, they must be corrected and the
documents resubmitted before the expiry date of
the L/c. Thus the exporter should make sure that
the expiry date allows enough time for errors
to be rectified.
Finally
- A Quick Checklist
Always make following checks with
your L/c:
-
Did you receive the letter of
credit directly from a bank? If your answer
is "No" - do not proceed any further as the
letter of credit has not been authenticated
and may be fraudulent.
-
Is the letter of credit irrevocable?
If your answer is "No", do not proceed any
further as a revocable letter of credit can
be "revoked" by the buyer without your consent.
-
Has the latest shipment date
passed? If your answer is yes, the letter
of credit must be amended to extend the latest
shipment date.
-
Is the letter of credit : Confirmed
by a U.S. or prime world bank ? Please see
above for correct procedure
-
Is the amount on the credit
correct?
-
Is the beneficiary's name and
address correct?
-
Is the buyer's name and address
correct?
-
Is the merchandise description
correct and consistent with other documents?
.
-
Do any of the documents in the
credit need to be legalized?
-
Which documents are required
in the Letter of Credit:
-
Commercial Invoice
-
Packing List
-
Insurance Certificate
-
Ocean Bill of Lading
-
Air Waybill
-
Other
|
