1. The Role of the Sales Contract
    As a general rule, the commercial letter of credit arises out of an international sale of goods or services. This chapter describes the international sales contract diagrammed in Illustration 1-1 and the role it plays in the letter of credit transaction. The letter of credit is independent from the sales contract, but follows it and serves as the payment mechanism for satisfying the seller/exporter’s price.

  1. The Sales Contract Terms
    International sales contracts range from the very simple to the very complex, but because the seller/exporter expects to be paid under a documentary credit and the buyer/importer typically expects its bank to pay for the goods before the buyer/importer has had a chance to examine them, the sales contract should address the following terms.

  1. Description of the Goods
    It is essential that the parties know what they are contracting to buy and sell, and the sales contract should describe the goods or services so that the parties can use this description, or a description that is not in conflict with it, in (1) the commercial invoice; (2) the transport documents; (3) the letter of credit; and (4) other documents that the parties may use to verify performance, allow the goods to move through customs or satisfy other government regulations. UCP 600 article 18 requires the description of the goods in the commercial invoice presented by the seller to the nominated bank to correspond to the description of the goods in the credit, and UCP 600 article 14(e) provides that the description of the goods or services in other documents must not conflict with that of the credit. The description in the contract will often serve as a template for the descriptions in these other important credit transaction documents.
  2. Shipping Terms
    The place, time and method of delivery figure in the documents that the letter of credit issuer will require for payment. UCP 600 article 6(d)(i) provides that the letter of credit must state the date on which the credit expires, and most letters of credit also specify a latest shipping date. Transport documents play a key role in the control of goods during and after transit, and nine articles in UCP 600 relate to different types of transport documents (see UCP 600 arts. 19-27). The issuer of the documentary credit will not review the contract of sale, so the buyer will need to provide the issuer with the latest shipping date from the contract and with an expiry that is realistic in terms of the seller’s expected performance.
    The contract should also specify who is responsible for arranging and paying for transportation, where the goods are to be shipped, at what point the seller’s responsibility for damage to the goods ends and whether the seller should take out insurance against damage to the goods beyond that point, and at what point title to the goods will pass from the seller to the buyer. A shorthand method for specifying many of these shipping details can be found in Incoterms 2000, ICC Publication No. 560. For example, the term “Free Carrier Detroit” (FCA Detroit) means that the seller is responsible only for packing the goods appropriately and handing them over to a carrier in Detroit for shipment to the buyer. The buyer must arrange and pay for transportation from Detroit to its own location and take responsibility for any damage to the goods after receipt by the carrier in Detroit. If cargo insurance is desired, the buyer must arrange and pay for it independently. The other Incoterms are:
  • ex works (EXW);
  • free alongside ship (FAS);
  • free on board (FOB);
  • cost and freight (CFR);
  • cost, insurance and freight (CIF);
  • carriage paid to (CPT);
  • carriage and insurance paid to (CIP);
  • delivered at frontier (DAF);
  • delivered ex ship (DES);
  • delivered ex quay (DEQ);
  • delivered duties unpaid (DDU); and
  • delivered duties paid (DDP).
    Extensive definitions can be found in Incoterms 2000, ICC Publication No. 560, or the companion book, ICC Guide to Incoterms 2000, ICC Publication No. 620.
    One matter the Incoterms should not be expected to cover is passage of title. In most ocean shipments, title will pass by using the transport document as a title document. If the transport document is not the desired means of transferring title, the contract should state when title passes, e.g. upon delivery or payment.
  1. Price
    Obviously, the parties have to agree on a price or a method for determining the price when the time for payment arrives. Several documents in the letter of credit transaction relate to the price, among them the commercial invoice (see UCP 600 art. 18), the letter of credit amount and the draft or demand for payment that triggers payment under the credit. Besides the value of the goods, the price may include the costs of freight and insurance when arranged and paid for by the seller.
  2. Quality
    The buyer/importer will specify the nature of the goods’ quality and whether the seller/exporter must make warranties of quality. Often, the warranty term will require the goods to meet industry standards, but sometimes a buyer/importer will insist on special warranties. The warranty term plays a role in the letter of credit transaction, as the letter of credit issuer will often, at the buyer/importer’s request, require documentation, such as an independent certificate from a reliable inspector, certifying that the goods satisfy industry standards or the special warranty agreed to by the parties in the sales contract.

  1. Payment Terms
  • Seller/exporters make delivery in anticipation of payment and may deliver against:
  • cash in advance;
  • cash on delivery (see chapter IV, section 2);
  • barter;
  • open account credit (see chapter IV, section 3);
  • documentary draft (see chapter VI);
  • avalized promissory notes (see chapter V);
  • documentary letter of credit (see chapters VII-XII); or
  • some hybrid of the foregoing.
  1. Governing Law
    When a buyer and a seller are in different countries, it is not always clear whose laws apply to the contract of sale. Rather than leaving the matter for the courts to decide, it is best to agree on the governing law at the time the seller and the buyer enter into the contract. If the parties prefer the law of a neutral jurisdiction, they might select the United National Convention on Contracts for the International Sale of Goods, which many think fits the bill in most cases. Furthermore, the sales contract should specify which courts have jurisdiction and under what circumstances alternate dispute resolution might be preferable to litigation. Many parties prefer arbitration to litigation. In that case, they should consider the ICC Rules for Arbitration.