Incoterms_® and Commercial Contracts

9.1 Introduction

a. Terminology: commercial credits vs. guarantees/bonds/standbys

The terms “letter of credit” and “documentary credit” mean the same thing. Traders and bankers in some parts of the world tend to use the term “letter of credit” or the abbreviation “L/C”, while some bankers prefer to use “documentary credit” or “D/C”.

The fundamental concept underlying all letters of credit is that an issuing bank’s obligation to make payment is subject to the beneficiary’s submission of documents complying with the letter of credit. As stated in Article 5 of UCP 600 “Banks deal with documents and not with goods, services or performance to which the documents may relate.” This chapter will use the terminology “documentary credit” or “D/C”.

This chapter reviews the use of documentary credits to effect payment for international commercial transactions. When documentary credits are used to pay for imported goods they are called “commercial credits”. Commercial credits are to be distinguished from “standby letters of credit” (see Chapter 10), which are typically used as guarantees or security devices rather than as primary payment devices.

When news reports refer to a “letter of credit” in connection with a large government aid project, they are usually talking about a standby credit, not a commercial credit. Governmental bodies or donors who wish to offer financial support often do so by issuing a standby credit to guarantee loans to the recipient.

b. Commercial credits for export payments and trade finance

Documentary credits substantially reduce trade risks for both exporters and importers. Over centuries of development, the letter of credit became the classic form of international export payment. Courts and judges referred to credits as the “lifeblood” of international commerce. The first function of a documentary credit is to protect the export seller from non-payment by replacing the credit-worthiness of the buyer with that of the bank issuing the D/C. Consequently, when a documentary credit clause is included in a sale contract it was usually put there at the seller’s request. A letter of credit is an irrevocable undertaking from the importer’s bank
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to the exporter (called the “beneficiary” in the D/C context) that the exporter will get paid if the exporter can prove it has shipped the proper goods by providing the corresponding documents required by the D/C. Export sellers like documentary credits because the advance assurance of payment ensures the seller that it will not waste time preparing or shipping an order to a buyer who will ultimately refuse to accept or pay for the goods.

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The documentary credit is notified to the seller in the form of a letter or advice from a bank stating that the credit amount is available at the bank for a certain period of time. This credit advice will also precisely specify the documents that the seller must present in order to get paid.

The documents typically required by the D/C (e.g., bill of lading, commercial invoice, inspection certificate, packing list, certificate of origin) provide a basic level of proof that the right merchandise has been properly shipped to the importer. As discussed below, however, it is not uncommon for exporters to submit documents that do not conform to the credit and, in such cases, payment under the credit may be refused.

A second function of the credit is to enable the seller to finance the transaction. Sellers are able to raise funds or secure loans on the basis of the security provided by the documentary credit. The credit may enable the seller to procure raw materials or manufacture the contract goods.

A third function of the credit is to protect the buyer. The seller cannot automatically receive payment unless it submits the documents required by the D/C (which establish that the correct goods are on their way to the buyer). Although documentary credits are usually requested by the seller, they sometimes end up offering even greater protection for the buyer. Thus, if a buyer specifies that one of the documents required under the credit is a certificate of pre-shipment inspection, the buyer is has a high assurance of conforming goods.

Another benefit of a credit for the buyer is that a seller’s mistakes or breaches are discovered soon after shipment of the goods, rather than upon receipt by the buyer (which may take weeks or months). This allows the buyer to promptly seek substitute or alternate goods.

c. Problems and risks with documentary credits

The most common problem associated with documentary credits is that sellers fail to appreciate the potentially grave consequences of documentary errors or “discrepancies” in the documents they present to the banks. Surveys have revealed that even in trading centres (such as London) banks report discrepancy levels over 50% (more than 50% of initial presentations of documents contain at least one discrepancy). In emerging markets, discrepancy rates of 60% to 90% have been reported.

The problem with discrepancies is that they can block payment under the documentary credit. Even a single discrepancy can prevent the seller from ever being paid. In actual practice, most discrepancies do not prove so catastrophic, because buyers are usually willing to forgive the discrepancy. When buyers still want to go through with the transaction, they waive their objection to the discrepancy or amend the credit. Export sellers are sometimes lulled into a false sense of security by the regularity with which buyers agree to waive discrepancies or amend credits. In falling markets, buyers may rely on the seller’s documentary errors to back out of a transaction.

Faced with a refusal of payment, inexperienced traders may express surprise or anger that the bank will reject documents because of a “minor” error (for example, a mistake in the beneficiary’s address). Traders must learn to understand that a single discrepancy is enough to totally block payment of a documentary credit. The long-term answer for exporters is to understand D/Cs better and to develop extremely meticulous document–management systems. Documentary credits provide enormous benefits for exporters, but they exact a strict complementary duty: documents presented under a credit must conform precisely to the requirements spelled out in the credit in order to obligate the bank which has issued the D/C.

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d. Alternatives to documentary credits

In certain international commodities markets, the use of documentary credits is so customary that it is practically a requirement of business. Documentary credits are particularly suited to commodities markets in which the goods are re-sold many times before reaching the end user.

However, in other kinds of international transactions, documentary credits may not be appropriate or helpful. Export sellers that are in extremely strong bargaining positions can avoid the documentary pitfalls of the letter of credit by insisting on payment backed by a standby credit (for example, open account payment backed by a standby credit). This structure eliminates the risk for the seller of presenting documents with minor nonconformities which may constitute discrepancies under a commercial D/C.

Buyers, conversely, who find themselves in strong bargaining positions should consider alternatives such as payment by documentary collection or payment on open account (neither of which require the buyer to guarantee funds in advance of shipment).

9.2 Rules for letters of credit: the UCP 600

International letter of credit practice has been standardized by ICC rules known as the Uniform Customs and Practice for Documentary Credits (UCP 600). The UCP demonstrates that international business self–regulation can be as effective as treaties, government regulation or case law. Indeed, legal commentators have called the UCP the most successful act of commercial harmonization in the history of world trade.

The first version of the UCP, UCP 82, was adopted in 1933. The rules gained broad acceptance in Europe. The 1951 revision brought the UCP to global scope, being used by banks in Asia, Africa, Latin America, the United States (limited to export credits) and a number of European nations, with the U.K. being one of the holdouts. The 1962 revision provided a major breakthrough, gaining the acceptance of the influential U.K. and Commonwealth banking community. Further revisions, adding technical refinements and improvements, were released in 1974, 1983 and 1994. The current version, UCP 600, entered into effect in 2007.

The UCP provides a more flexible set of rules than comparable national or international legislation. When the United Nations drafts an international treaty or convention, for example, the entire process can take decades. Revisions of such treaties can also be lengthy affairs, so it is relatively rare to see the revision of a major international trade treaty.

The UCP, by contrast, is not binding law, but it applies because buyers and sellers voluntarily incorporate it into the contracts upon which the letter of credit is based. In essence, the UCP is the codification of actual trade practices, based on the experiences of trade banks, exporters and importers. The UCP can thus be more easily updated than an international law or treaty. Periodic revisions have allowed the rules to keep in step with advances in banking practice.

The UCP rules apply when they have been voluntarily incorporated by the parties. Documentary credit application forms usually contain a notation that the credit will be subject to the UCP 600. This “incorporation by reference” expresses the parties’ agreement to submit interpretation of the credit to the rules of the UCP.

After more than 80 years of existence, the UCP has achieved such universal acceptance that in some countries the rules are recognized as having the force of law, or at least that of a
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trade custom. However, in other countries, such as the United Kingdom, the UCP does not have formal legislative status and will only apply when the parties specifically incorporate the rules into the documentary credit by explicitly invoking the UCP on the credit application forms. In the United States, the Uniform Commercial Code governs the use of letters of credit, but the UCP is considered to govern when the parties have specifically incorporated the UCP or when the UCP is the customary trade practice.

Even where the UCP is applicable, its somewhat general provisions cannot cover all cases. As a result, national courts are often asked to interpret certain provisions. The ICC Banking Commission also regularly issues interpretations of provisions of the UCP based on questions received by ICC, which collects and publishes these Opinions every few years, providing a valuable aide for practitioners. The most recent versions are Collected Opinions of the ICC Banking Commission 1995–2001 (ICC Publication 632), Unpublished Opinions of the ICC Banking Commission 1995-2004 (ICC Publication 660) and ICC Banking Commission Opinions 2005-2008 (ICC Publication 697). These are available at www.iccbooks.com.

Although it is beyond the scope of this text to go in detail through the numerous refinements and improvements included in UCP 600, the most important ones deserve brief mention here:

• A credit is now deemed to be irrevocable even if there is no indication to that effect. UCP 600 does not discuss revocable credits.
• The bank examining the documents has a maximum period of five banking days following the day of presentation to determine if a presentation is complying (the previous position under UCP 500 was that banks had a reasonable time not to exceed seven banking days following the day of receipt of the documents to examine such documents).
• Complying presentation - Article 2 provides a definition of this term - stating that it “means a presentation that is in accordance with the terms and conditions of the credit, the applicable provisions of these rules and international standard banking practice”. Whilst the ICC has issued a publication International Standard Banking Practice for the Examination of Documents 2007 revision for UCP 600, the reference in the UCP to “international standard banking practice” is not confined to the content of this publication.
• Definitions and Interpretations - two new articles in the UCP cover defined terms that are used in the UCP and interpretations of words or clauses that are regularly seen in letters of credit.

9.3 Basic concepts and terminology

(depending on their role in the transaction)
The seller/exporter may be referred to as:

• Beneficiary - because it is the seller who receives payment from the letter of credit;
• Shipper - because the seller ships the goods;
• Consignor - again, because the seller ships the goods - sometimes referred to as “consignment” in international transport.

The buyer/importer may be referred to as:

• Opener - because the importer “opens” the credit process;
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• Applicant - because the importer must begin the process by submitting a credit “application” to a bank;
• Account party - because the issuance of a D/C is an extension of credit by the issuing bank to a client (clients have accounts).

1. Issuing (or “opening”) bank - The issuing bank receives the importer’s application and agrees to “issue” or “open” the credit. The issuing bank is commonly, but not necessarily, located in the importer’s country. By issuing the credit, the bank is making an irrevocable undertaking to pay the beneficiary the value of the draft and/or other documents, provided that the terms and conditions of the credit are complied with.
2. Nominated bank - The bank which is stipulated in a credit as authorized to honour (pay, issue a deferred payment undertaking or accept drafts) or negotiate. Unless a credit expressly states that it is available only with the issuing bank, it should nominate some other bank. If the credit is of the “freely available” variety, any bank qualifies as a nominated bank. A nominated bank is not normally bound to pay under the credit unless it has added its confirmation to the credit and become a confirming bank (see point 4).
3. Advising bank - The bank which notifies or “advises” the exporter that a credit has been opened in the exporter’s favour. By advising a credit, the bank is only acting as a conduit for the issuing bank; the advising bank does not take any further risk, and only has the responsibility of satisfying itself as to the apparent authenticity of the credit and ensuring that the advice of the credit (to the beneficiary) accurately reflects the terms and conditions of the credit received. The advising bank is commonly, but not necessarily, located in the exporter’s country. An advising bank will frequently perform one or more of the functions of confirming, honouring or negotiating, which are defined further on.
4. Confirming bank - The bank (normally also the advising bank) which adds its own irrevocable undertaking (known as “confirmation”) in addition to that given by the issuing bank. The confirmation allows the exporter to be assured payment by a bank in the exporter’s own country, or by a bank which the exporter otherwise trusts. The confirming bank irrevocably commits itself to honouring the presentation of conforming documents. As with the role of paying bank, the bank accepting the role of confirming bank exposes itself to the risk that it will fail to detect a discrepancy in the documents and also takes on the risk it may not be able to recover the funds from the issuing bank.
5. Paying (or “paying agent”) bank - The bank that reviews the documents presented by the exporter and, if they comply with the terms and conditions of the credit, arranges payment to the exporter. A paying bank’s main risk is paying against documents that turn out to contain discrepancies, in which case it may not be able to recover the funds from the issuing bank. However, a bank acting as paying agent may refuse to pay the exporter if the issuing bank’s account is not sufficient to cover the draft (this applies where the bank has not added its confirmation to the letter of credit). A confirming bank makes payment “without recourse.”
6. Negotiating bank - The bank which examines the documents presented by the exporter, then “negotiates” the credit (i.e., in the case of a usance draft, either advances or agrees to advance funds to the beneficiary on or before the maturity date of the draft).
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   This negotiation, or purchase, is usually done “with recourse”, which means that if the issuing bank fails to reimburse the negotiating bank, the negotiating bank will recover the funds advanced to the exporter. This distinguishes the negotiating function from the confirming function. When a confirming bank negotiates, it is “without recourse”, which means that even if no reimbursement is received from the issuing bank, the confirming bank cannot recover the funds from the exporter.

1. Irrevocable/revocable – An irrevocable letter of credit cannot be amended or cancelled without the consent of all parties. This essential undertaking allows the exporter to procure the goods or prepare them for shipment with the assurance that payment will be received if the stipulated documents are presented and comply with the terms and conditions of the credit. A revocable letter of credit provides little if any security for the exporter and is consequently unusual. UCP 600 does not cover the issuance of revocable credits due to the rarity of this type of document. If an applicant wishes to issue a revocable credit under UCP 600, the issuing bank will be required to insert all the conditions of the revocability into the credit.
2. Confirmed – As stated in the definition of confirming bank above, a credit is confirmed when a bank (usually the advising bank in the exporter’s country) adds its own irrevocable undertaking at the request, or with the permission of, the issuing bank in addition to that of the issuing bank. Generally, this assures the exporter of payment by a local bank.
3. Sight/Usance – Credits may provide for payment at sight (immediately) or for payment at a specified time in the future - a usance credit.
4. Revolving – If the importer is a regular customer of the exporter, the parties may wish to arrange for a revolving credit. Under a typical revolving credit, the bank issues a credit for a certain maximum sum which is automatically renewed at certain intervals. Revolving credits save the parties from the administrative tasks of having to repeatedly re-apply and re-issue similar credits. Although revolving credits do have expiry dates, they tend to be valid much longer than normal credits.
5. Red clause – A red clause credit allows pre-shipment advances to be made to the exporter at the risk and expense of the applicant. Under a red clause credit, the bank will honour the exporter’s sight drafts up to a specified percentage of the total credit against production of certain preliminary documents. Originally, the clauses specifying a red clause credit were actually printed or typed in red ink, hence the name. Obviously, such credits should only be used when the importer has great trust in the exporter.
6. Transferable – Transferable credits are used in “middleman” situations, where an export merchant or agent plays the role of an intermediary between a supplier and the importer. The middleman–beneficiary transfers all or a portion of its rights to a supplier-beneficiary (known as the “second beneficiary” in the UCP). The middleman may not wish to reveal the identity of the ultimate supplier and may keep this information from the importer by substituting the middleman’s invoice for the ultimate supplier’s invoice. Transferable credits can become exceedingly complex, so importers and exporters should proceed with some caution. In particular, the importer may accept the risk that the ultimate source of the contract goods remains unknown; therefore, it is difficult for the importer to be assured of the ultimate supplier’s reputation and reliability, and the exporter may discover it is not possible to completely hide the identity of the ultimate supplier.
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7. Back-to-back – Under a back–to–back credit, the middleman-beneficiary uses the letter of credit as security for the issuance of a second, separate credit in favour of the ultimate supplier. Whereas under a transferable credit the importer must request the transferable credit in the application, under a back-to-back credit the importer may be ignorant of the back-to-back arrangement. Although the middleman may, therefore, wish to use a back-to-back credit if it wishes to conceal its recourse to an ultimate supplier, the middleman takes an additional risk in doing so. With the back-to-back procedure, the middleman must repay the bank for any valid payment to the ultimate supplier under the second letter of credit, regardless of whether or not the middleman receives payment under the first letter of credit. This is a major risk area for banks, which are very cautious as regards issuance of back-to-back credits.
8. Standby – The standby credit is to be distinguished from the above-defined letters of credit in that the primary function of the typical standby is to serve as a security or guarantee rather than as a payment mechanism. Under a typical standby, the beneficiary will claim payment in the event the contract partner has failed to perform or fulfil certain obligations. Standby credit practice largely developed in the United States, where banking law long forbade banks to issue guarantees. Recent changes in the law, however, do not seem to have significantly altered American bankers’ extensive reliance on standby credits, and standby practice has spread outward from the U.S., so that they are now issued in many countries. From a legal point of view, standbys are virtually indistinguishable from bank guarantees. In practice, however, standbys appear to be used for a much broader spectrum of uses. Although standby credits are specifically referred to in UCP 600, the majority of the UCP articles have no direct bearing on the issuance or handling of this type of credit. In fact, a number of articles were considered to be inappropriate for standbys, which is one reason a separate set of rules for standbys, called ISP98, were developed (see Chapter 11). Note that standbys may also be issued subject to the ICC Uniform Rules on Demand Guarantees (ICC Publication 758) (see Chapter 11).

The sale contract should clearly specify that payment will be by confirmed irrevocable letter of credit if the exporter wishes to insist on this highly secure form of payment. The sale contract is sometimes referred to as the underlying contract in relation to the documentary credit operation. As will be discussed later, it is a fundamental principle that the documentary credit is independent and autonomous of the contract of sale, meaning that disputes under that contract cannot normally prevent payment under the credit. However, the buyer/ importer must request in the credit application that the credit be opened in accordance with the conditions specified in the contract of sale.

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The sale contract may or may not provide additional details or conditions with respect to the credit (as, for example, the time of payment, the documents to be presented, etc.). The export seller will normally insist on a confirmed credit when it is less than fully confident in the credit risk of the issuing bank, or when it fears that there may be political or foreign exchange risks associated with the buyer’s country.

Assuming that the parties have agreed to the terms of the documentary credit in the sale contract, the importer will apply to its bank for the credit to be issued, thus becoming the applicant. The credit application, when accepted, constitutes a contract between the importer-applicant and its bank (the issuing bank). The bank agrees to issue the documentary credit, and the importer-applicant agrees to reimburse the bank for payments made under the credit. Since the bank will open a credit that follows the instructions given by the importer, it is up to the importer to make sure that these instructions do not contradict the contract of sale (if there is a contradiction, the importer will be in breach of the contract of sale).

Although the applicant must respect the terms of the contract of sale, it is quite common for the contract of sale to be silent on one or more terms and conditions stated in the D/C. In such cases, the applicant may include additional details, but the exporter-beneficiary may not be bound under its contract to accept them when it reviews the credit, although it will have to comply with the terms and conditions of the credit or seek a suitable amendment(s).

Inexperienced exporters may be tempted to transpose the conditions of the contract into the credit application. However, great care should be taken that the credit does not contain any non–documentary conditions (conditions that cannot be established by a specific document), as such conditions cannot be enforced.

Amongst the minimum details that will be specified in the credit application are:

1. Time of payment – Specifying whether the credit will be payable at sight or at a later date (a usance credit);
2. Date and place of expiry of the credit – This date should give sufficient time for the beneficiary to prepare, ship the goods and present documents;
3. Latest date for shipment and presentation of documents – As above, these time limits should be reasonable in light of circumstances to allow the beneficiary to perform its obligations; in any event, should the credit be silent on the time allowable for presentation of complying documents to the nominated bank after the date of an original transport document, UCP 600 specifies a maximum period of 21 calendar days;
4. Beneficiary – The beneficiary’s name and address must be exactly and completely spelled out;
5. Type of credit – i.e., irrevocable, confirmed, transferable, etc;
6. Currency and amount – A credit must state the currency in which it is payable. In some cases, due to uncertainty as to the exact quantities to be shipped or the freight rate, the sale contract will only have contained an approximate price. The credit may, therefore, specify an amount which is “about” or “approximately” a certain sum, in which case a 10% variation will be allowable; alternatively, the credit may specify a maximum amount through the use of such words as “up to”;
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7. Shipment details – These will specify, inter alia, whether partial shipments or transhipments are allowed. Unless the applicant has strong reasons for disallowing partial shipments, it is better to allow them, as they provide flexibility for the beneficiary. If the goods are of a hazardous or bulky nature that may require carriage on deck, the credit should specifically allow for bills of lading indicating that such carriage has occurred;
8. Goods – It is important that the goods not be described in excessive detail, which can give rise to disputes later when documents are presented; rather, the description of the goods should be general but with sufficient detail to identify the contract goods and permit their movement under applicable regulations. It is advisable for applicants to identify the contract by its reference number. Applicants may also wish to require that the beneficiary provide a certificate to the effect that all conditions of the contract have been complied with. In no case should contractual documents (such as pro forma invoices or technical specification sheets) be attached to the letter of credit, as these multiply the opportunities for confusion and mistakes;
9. Documents – The documentary requirements are of the utmost importance and should be carefully thought through by the applicant, as it is likely that they will undergo close scrutiny by the beneficiary when the credit is received. In general, applicants should be discouraged from asking for an excessive number of documents or from insisting on voluminous originals when single original documents or photocopies will do. The prudent beneficiary will understand that as the number of documentary requirements increases, so does the possibility that a document will contain a discrepancy and therefore block payment under the credit.

The importer makes the credit application by filling in a standard form provided by the bank. The application form has been designed to correspond with the model form for the credit itself, thereby greatly facilitating the transfer of information from the application to the credit.

The issuing bank will decide whether or not to issue the credit after considering the importer’s creditworthiness. From the bank’s point of view, the documentary credit amounts to a borrowing request by the importer for the time period dating from the opening of the credit until its expiry date or maturity date for payment.

The bank issues a documentary credit in favour of the exporter-beneficiary under which the bank agrees to pay the beneficiary, provided the beneficiary presents documents that comply with the terms and conditions of the credit. It is said that this irrevocable undertaking constitutes the third “contract” of the documentary credit mechanism (although under some systems of law, it is not a true contract owing to the unilateral nature of the undertaking). The first contract is the contract of sale between the exporter and buyer, and the second is the one formed by the credit application, whereby the bank agrees to issue the credit for a fee and the applicant agrees to reimburse the bank for payments made under the credit.

When the credit application specifies a confirmed credit, the issuing bank will request that another bank, usually in the beneficiary’s country, confirm the credit. By confirming the credit, the confirming bank adds its irrevocable obligation to that of the issuing bank. The exporter is thus assured of a second reliable paymaster, this one in its own country.

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The confirming bank’s decision to confirm will involve a credit analysis of the issuing bank’s credit risk as well as the relevant political and foreign exchange risks. Having confirmed the credit, the confirming bank must honour or negotiate upon presentation of complying documents by the beneficiary, regardless of the issuing bank’s ability to reimburse the confirming bank. The confirming bank advises the confirmed credit to the beneficiary. The confirming bank’s undertaking to pay now constitutes the fourth contract in the chain.

When the exporter receives the letter of credit, it is strongly recommended that it immediately review it, carefully checking it against the terms of the contract in light of the anticipated circumstances of the shipment.

As noted earlier, a disturbingly high percentage of documentary credit transactions encounter difficulties upon first presentation of documents (as many as 50%-90%, depending on the country). One of the reasons is that sellers often neglect to review the credit when they receive it. An immediate review allows sellers to detect in due time any inconsistencies with the contract of sale, or with their intended means of preparing or shipping the goods.

If the exporter, on reviewing the credit, realizes that it would be impractical or impossible to comply with its terms, it should immediately notify the importer and request that the credit be amended. The exporter should verify that the credit is actually amended and that it is notified of the amendment. It is unfortunately not unheard of for the exporter and importer to agree to an amendment, but neglect to inform the issuing bank, thereby permitting a troublesome discrepancy to arise.

In order to be paid under the credit, the exporter must prepare the goods for shipment in due time, and must assemble all the necessary documents. The exporter is well advised to check the documents against the documentary credit specifications before presenting them to the bank.

It is highly recommended that the beneficiary present the documents as early as possible. This is because the bank will take a certain amount of time to examine the documents (a period which cannot exceed five banking days following the day of presentation under UCP 600) and, in the event the bank detects a discrepancy which can be corrected, the beneficiary will want to have enough time to correct the discrepancy and re-present the documents before the expiry of the credit or the latest presentation date.

After shipment, the beneficiary presents the documents (and a draft in those common cases where the credit calls for a draft) to the confirming bank.

The confirming bank will carefully examine the documents presented by the beneficiary against the terms and conditions specified in the letter of credit. The bank will note any discrepancies (differences between the documents presented and the terms and conditions of the credit), or will observe that the documents are complying.

Under the UCP, the bank must conduct its examination of the documents within a maximum period not to exceed five banking days following the day of presentation (this is equally true for the issuing bank, confirming bank and/or a nominated bank willing to act on its nomination). The bank must notify the beneficiary of a decision to refuse the documents by telecommunication or other expeditious means, in no event later than the maximum period specified above.

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If the documents are found to be complying, the bank will honour (pay, accept or incur a deferred payment undertaking) or negotiate under the credit, according to its terms. A confirming bank’s settlement to the beneficiary is without recourse, which means that the confirming bank cannot recover the funds from the beneficiary, regardless of the issuing bank’s subsequent decision not to reimburse the confirming bank. There may be an exception to this rule in some jurisdictions, with the effect that a bank can recover the funds if it can prove fraud by the already paid beneficiary.

If the documents are discrepant, the exporter may be able to correct them if there is still time remaining before the expiry date of the credit or the last day for presentation, and provided that the discrepancies are of a nature that permits correction. Obviously, some discrepancies cannot be corrected (transport document shows late shipment, credit overdrawn, etc.), regardless of the time frame.

Should the beneficiary for whatever reason be unable to correct the documents, it may still approach the applicant for a waiver of the discrepancy. The approach may be made directly or via the advising or confirming bank that will contact the issuing bank. The issuing bank is the only bank authorized by the UCP 600 to contact the applicant for a waiver. An applicant may be willing to grant a waiver, especially if the discrepancy appears to be an insignificant one and there are strong commercial reasons for going through with the deal. Unfortunately, it sometimes happens that applicants use discrepancies as an opportunity to bargain for discounts from exporters, which is all the more reason for beneficiaries to prepare the presentation of documents with great care.

The issuing bank will also review the documents it has received from the confirming bank (or another nominated bank). If, in the judgement of the issuing bank, the documents are discrepant and the confirming bank has made an error in paying under the credit, the issuing bank can recover the funds for which it has been debited by the confirming bank. Under sub-article 14 (b) of UCP 600, the issuing bank must take no more than a maximum of five banking days following the day of presentation to examine the documents and determine whether or not they will take up or reject them.

If the issuing bank’s review indicates that the documents were, in fact, complying, then it will debit the account of the applicant (or advise the applicant of the due date on which its account will be debited) and release the documents to it. The documents (particularly the document entitling control of the goods, such as the marine bill of lading), will allow the importer to collect the goods from the carrier. Although not addressed in the rules, the importer should also immediately conduct its own review of the documents. It is possible that the importer may discover a discrepancy that has been missed or ignored by the banks. In such a case, and depending on applicable law and the language of their credit application, the buyer can refuse to reimburse the issuing bank and can itself reject the documents. This is why banks conduct such painstaking examinations of the documents.

9.5 Independence and strict compliance: the basic principles of D/C practice

The two fundamental principles of D/C practice are found in:

1) the independence of the credit from the underlying contract, and

2) the requirement that documents strictly comply with the terms of the credit.

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The documentary credit is independent of the underlying contract. This means that if the exporter fulfils the documentary obligations of the credit, payment must be effected under the credit regardless of disputes connected to the underlying contract. Thus, the exporter’s breach of a contract condition (i.e., with respect to quantity, quality, delivery date, etc.) is not sufficient to entitle the importer to instruct its bank to stop payment under the credit. This rule is essential so that parties remain confident that banks will respect their D/C payment commitments. The payment obligation of an issuing bank is therefore separate and autonomous from the underlying export contract.

The principal exception to this rule has to do with fraud. A bank that receives a clear notification or proof of fraud committed by the beneficiary is not only entitled, but may be obliged under applicable law to withhold payment. However, banks are not required to investigate mere suspicions of fraud.

Courts are quite reluctant to grant injunctions ordering a bank to withhold payment, so clear indications of fraud are generally necessary. Since letter of credit practice to some extent has arisen to avoid risks related to the lack of knowledge or trust between the two trading partners, it is essential that both parties trust the banks. Letters of credit could not function if the parties lacked confidence that the banks would honour their obligations regardless of arguments submitted by the parties. Judges have referred to letters of credit as the “life blood” of international commerce. If banks were allowed to refuse to pay letters of credit whenever trading parties had a dispute, the vital flow of international commerce would soon be blocked.

In some cases, the issuing bank’s officers may be obliged to resist pressure from the applicant to bend the principle of absolute neutrality and independence. Whenever the buyer-applicant has a suspicion that the goods are non-conforming, the buyer may wish to stop payment under the credit. Unfortunately, however, it is quite possible for a seller to send bad merchandise (so long as this does not amount to a clear fraud) and yet present good documents. That is one of the reasons a pre-shipment or post-arrival inspection certificate is so frequently called for. If the importer learns that it may receive an inadequate or late shipment, it may sue for damages for breach of contract. But this action would be outside the letter of credit and the UCP.

The terms of the letter of credit must be strictly adhered to: this is known as the doctrine of strict compliance. What this means in everyday practice is that documents presented under the credit must comply very precisely with the terms and conditions of the credit.

In the letter of credit process, the issuing bank acts on the instructions contained in the credit application in issuing the credit and as a neutral paymaster in examining the exporter’s documents to determine compliance and honour. The great majority of letter of credit disputes concern discrepancies in the documents, so bankers’ decisions as to discrepancies must be based on the doctrine of strict compliance.

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Thus, both exporters and the respective banks must take care that the data in documents is correct. Exporters sometimes complain that banks go to excessive lengths to make sure the documents are exactly correct, even down to the spelling of unimportant words. But it should be noted that if the bank pays against even a single discrepancy, it may find itself faced with an applicant that refuses to reimburse it for that payment. An additional justification for banks’ meticulous checking for discrepancies is that banks cannot be expected to be expert in all areas of business. What is clearly a “trivial” discrepancy to an exporter may not be clear to the bank. For example, a bank cannot be expected to know that two different technical words actually mean the same thing.

In one celebrated legal case¹, the letter of credit application specified that the contractual goods were “Coromandel groundnuts”. The bill of lading referred to them, however, as “Machine-shelled groundnut kernels”. In reality, these were exactly the same types of merchandise, but the bank refused to pay the credit. The court upheld the bank’s decision on the grounds that bankers are not required to be experts in the terminology of nuts, nor in the terminology of any of the thousands of trade sectors for which letters of credit are issued. In many legal cases, where a bank has rejected a credit because of apparently trivial discrepancies in the wording on required documents, the bank was found to have acted correctly by courts of law.

Unfortunately, it is difficult to state any universal principle concerning just how “big” or “small” an error must be in order to count as a discrepancy. The significance of misspelling and mis-numbering, for example, is a common source of dispute. The 2007 revision of
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International Standard Banking Practice for the Examination of Documents Under
Documentary Credits (ICC Publication 681) puts it this way in paragraph 11: “A misspelling
or typing error that does not affect the meaning of a word or the sentence in which it occurs
does not make a document discrepant. For example, a description of the merchandise as
‘mashine’ instead of ‘machine’, ‘fountan pen’ instead of ‘fountain pen’ or ‘modle’ instead
of ‘model’ would not make the document discrepant. However, a description as ‘model
123’ instead of ‘model 321’ would not be regarded as a typing error and would constitute
a discrepancy.” As a general rule, however, exporters should be careful to ensure that the
spelling and description of goods in the commercial invoice are correct and in conformity
with the credit.

There is always the possibility that the importer will waive any discrepancies in the documents presented, and this is likely whenever the importer still wants the goods. Therefore, a waiver is probable if the market is rising and if the goods have increased in value, or whenever the buyer needs the goods to fulfil another contract. In any event, the importer must quickly make the decision whether or not to waive discrepancies to avoid exceeding the time limits the issuing bank has for refusing documents.

9.6 Checklist: recommendations for letter of credit practice

For the exporter/seller

Before beginning to use credits: make sure that you have implemented a rigorous document-management and verification system. Small errors can be extremely costly. Ideally, try to tailor the documentary credit to your commercial context by specifying in the contract of sale precisely the type of credit that you require:

• Carefully evaluate the credit as soon as you receive it - request the buyer to amend the credit if you think you may have any difficulty in complying with its terms.
• Prepare the exact documents called for in the credit - do not volunteer unnecessary information.
• Verify - the type of document requested, e.g.:
  – an insurance certificate, or
  – an insurance policy?
• Present the documents as early as possible and well before the relevant time limits.
• Make sure corrections are authenticated by the issuer or its appointed agent and the party making corrections is clearly identified.
• Make sure your company is properly listed as the intended beneficiary.
• If possible, ensure that one person in your company is given central responsibility for controlling, coordinating and verifying the progress of the letter of credit.
• Understand and select the correct Incoterm® 2010.

For the buyer/opener/credit applicant

• Do not include excessive detail; avoid complex, technical specifications.
• Make sure that the credit accurately reflects the contract.
• Do not require documents not previously agreed with the exporter/seller.
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• Do not include non–documentary provisions; for example, any inspection must be evidenced by a document; quality should be evidenced by a certificate. Avoid stating conditions not linked to the presentation of a document that evidences compliance therewith.
• Do not call for documents the seller cannot provide, i.e., a marine on board bill of lading when combined or containerized transport will be used.
• Request the issuing bank for advice or assistance in case of any doubt.
• Seriously consider while negotiating your contract whether you are willing to grant a credit without requiring an inspection certificate. Although many exporters are reluctant to provide such certificates, they are the buyer’s best assurance that the goods that were shipped met the contract quality requirements. One compromise is for the buyer to pay for the inspection.
• Understand and select the correct Incoterm® 2010

For the banks

• Assist the applicant to avoid problems with transport documents, especially if combined transport is called for:
  – is transhipment prohibited?
  – is a multimodal type document authorized?
  – is the place of dispatch specified, or a port?
• Counsel inexperienced buyers on the value of inspection certificates.
• Periodically review the wording of the credit application form; ensure that it conforms with Incoterms® 2000 and UCP 600; check it against the model forms provided by ICC.
• Do not exceed the maximum period for review of documents, even if the applicant is requested to waive possible discrepancies. Understand that the UCP specifies a maximum period of five banking days following the day of presentation, but that courts in particular countries may enforce a substantially shorter period.
• As issuing bank, if you believe the incorrect Incoterm® 2010 has been used, do not unilaterally alter the Incoterm suggested by the applicant (it may be already incorporated in a sale contract); instead, suggest to the applicant the advisability of contacting the counterparty to have the contract modified before issuing the credit.

9.7 The electronic supplement to UCP 600 (eUCP)

a. History

With the emergence of electronic documents - e.g., shipping records, customs clearance and banking documents - in the late 1990s, it became clear that ICC would have to adapt the UCP. In 2001, ICC approved a set of rules known as the “Supplement to UCP 500 for electronic presentation - version 1.0” (ICC Publication 500/3), termed “eUCP” for short.

Consisting of 12 Articles, the eUCP was a supplement to, and not a replacement of, UCP and was intended to be used in tandem with UCP where part-electronic or all-electronic presentations were made. The eUCP was subsequently updated to accord with UCP 600; the latest version of eUCP is numbered 1.1

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b. “Presentation”, not “issuance”

The eUCP does not address any issues relating to the issuance or advice of credits electronically, since current market practice and the UCP have long allowed this to be done. Consequently, many articles of the UCP are not impacted by the electronic presentation of the equivalent of paper documents. This means that a number of UCP articles - including those on transfer of credits, for example - are affected by the supplement only in relation to presentation. In other words, for any transaction involving all-electronic or part-electronic presentation, if the eUCP is silent regarding an electronic issue, the UCP prevails.

c. “Part-or all-electronic presentations”

If they are incorporated in the credit, the eUCP can apply to credits involving either part- or all-electronic presentations. The eUCP recognizes that presentations are likely to be mixed, electronic and paper, for some time.

In a mixed presentation, if paper documents are presented under an eUCP credit, they must identify the credit to which they are linked. Moreover, the eUCP makes clear that if a credit is issued subject to eUCP, and yet contains only paper documents, then only the UCP will apply.

d. Specific incorporation of the eUCP

The eUCP only come into play when specifically incorporated into the credit. Practically, this means that if the parties incorporate the eUCP, the credit is automatically subject to it and to the UCP as well. But if they only incorporate the UCP, this does not automatically make the credit subject to the eUCP.

e. Other key issues

1) “CORRUPTED” ELECTRONIC RECORDS

In article e11, the eUCP addresses the issues that arise when an electronic record is received but which, for technical reasons, is not capable of being read or which may contain a virus rendering it harmful to the recipient’s operating system. In such circumstances, the article leaves the bank/recipient of the electronic record a choice: the bank “may” request that the electronic record be re-presented. If re-presentation does not occur within 30 days, the bank can consider the record to have not been presented.

2) FORMAT

The eUCP does not specify the format in which electronic messages should be sent (e.g., in the body of an e–mail or in a text document attached to an e-mail). It is up to the parties to agree on the forms of electronic messages they can accept. Article e4, which deals with format, says that an eUCP credit “must” specify the formats in which electronic records are to be presented. If it does not, the record can be presented in any format, and the bank/recipient cannot raise objections concerning the nature of the format used (unless the record is “corrupted” (see above)). The eUCP is “technology neutral”; they are broad rules designed to deal with any technology that may be on the market, whether this be electronic imaging techniques, Internet transmissions or other any other electronic system

3) AUTHENTICATION

Article e5 (f) makes clear that “an electronic record that cannot be authenticated is deemed not to have been presented.” However, the rules do not define authentication and therefore
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leave it to the parties to decide on what means of authentication (i.e., digital signatures) they choose to employ.

4) NOTICE OF COMPLETENESS

When one or more electronic records are to be presented, the eUCP requires the beneficiary to provide a notice to the bank signifying when the presentation is “complete”. This differs from the UCP, which has no such provision regarding presentation when paper documents are involved. With part-electronic or all-electronic presentations, however, the situation is different: documents may arrive at different times and in different formats, unlike paper documents that usually arrive in a single package. This is the reason that, in the eUCP, a final act is required to indicate when the presentation is complete.

The eUCP makes clear that this “notice of completeness” can be sent either by telecommunication or by a paper document. This provision was included to cover those cases in which, for one reason or another, e.g., the failure of a system, etc., a bank is not able to receive electronic documents.

f. Major elements of the eUCP

The eUCP, as indicated, is a relatively brief supplement to UCP 600. The parties should refer to the eUCP version currently in use. If they do not, the latest version will apply.

The 12 Articles of Version 1.1 of the eUCP are as follows:

• Article e1 Scope of the eUCP: (Its use for presentation of part - or all-electronic documents; the need to incorporate the eUCP in a credit; the need to state the version number of the supplement);
• Article e2 Relationship of the eUCP to the UCP: (When the eUCP prevails over the UCP; consequences if only paper documents are presented under an eUCP credit);
• Article e3 Definitions: (Basic eUCP definitions of key terms, such as “appear on their face”, “document”, “sign”, “electronic record”, “format”, etc.);
• Article e4 Format: (Statement that credit should specify the format in which electronic records will be presented and consequences if it does not);
• Article e5 Presentation: (Need to state a place for presentation of electronic records; requirement for a notice of completeness; need to identify the eUCP credit for each presentation, etc.).
• Article e6 Examination: (When an electronic record contains a hyperlink; significance of a nominated bank forwarding electronic records; consequences if an issuing or confirming bank is unable to examine an eUCP credit in the format specified);
• Article e7 Notice of Refusal: (Time period for examining documents; when the time is extended; consequences if an issuing, confirming or nominated bank does not receive instructions from the party to whom the notice of refusal is sent);
• Article e8 Originals and Copies: (Presumption of originality if one electronic record is presented);
• Article e9 Date of Issuance: (Implications if an electronic record does not contain a specific date of issuance);
• Article e10 Transport: (Consequences when an electronic record does or does not indicate a date of shipment or dispatch);
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• Article e11 Corruption of an Electronic Record after Presentation: (Steps to take if an electronic record appears to be corrupted; what happens if a bank requests that a corrupted electronic record be re–presented);
• Article e12 Additional Disclaimer of Liability for Presentation of Electronic Records under eUCP: (Statement indicating that banks, in checking the apparent authenticity of an electronic record, assume no liability for the identity, source of the information; etc.).

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