Letter of Credit In Electronic Trade Transaction

Somewhere in 1990s some 40 bankers, carriers and multinational companies have joined together in the BOLERO project. BOLERO aims at providing an electronic Bill of Lading for use in export transactions. Banking software packages and specialized telecommunications networks such as SWIFT have already taken a lot of paperwork out of the business of preparing and transmitting letter of credit details. eUCP has been introduced by the ICC to focus on the presentation of electronic or partial electronic documents.

Internet, undoubtedly has become an important medium for business community to get connected and to carry out their business transactions safely with the help of digital signature authentication system. The internet facility also makes buying a large business abroad possible through the internet franchise service. This electronic medium has also made the status inquiry and the due diligent process completed much faster without exchanging papers back and forth. By clicking on computer franchise for example, buyer or seller can obtain information and get connected. Internet franchise or computer franchise provides a focal point for trading community in search for business diversification.

When the idea of electronic trade transaction takes a full swing, the quality of the evidence provided by the seller with regard to the goods is very important. The buyer, in his instructions to the bank, specifies what the bank is to accept as evidence. In practice, this is a set of documents issued by the seller and by the independent parties.

A letter of credit consists of a series of flows; instructions, money, evidence regarding the goods and the title to the goods. Most of the flows are already dematerialized, or could be. For example, instructions with regard to the letter of credit can be passed from buyer to bank, and from bank to seller by electronic means and many banks have implemented systems to allow this to happen. Indeed, there is even a North American Bank which is prepared to accept applications for letter of credit over the World Wide Web. Within the banking system, this type of instruction can be handled through SWIFT, using its MT700 message format.

The issues seem to be concentrated in the field of evidence and of title to the goods. If we concentrate on the evidence, there seems to be no reason why a buyer could not call for the bank to accept a certain set of electronic messages instead of the equivalent set of documents. There exist internationally accepted standard EDIFACT messages, which can carry all the data the buyer may require, and which correspond in every way to the documents normally used.

Discrepancy Fee: The Unnecessary "Evil"

Today, it is impossible to receive a letter of credit without a clause “…a discrepancy fee of USDxx will be deducted…”. This clause becomes popular in pursue to curb discrepant documents being presented to the banks. There was a period where discrepant documents had reached 60% of the total documents presented under letter of credit worldwide.

Most of the documents, in many cases are issued by a third party for example, Bill of Lading, Insurance Certificate, Certificate of Origin, Inspection Certificate and etc. If any of these documents is found to be discrepant, it would take some time for the seller to get it rectified and most probably would not meet the time limit for presentation or expiry date of the letter of credit. It is however agreeable, that the onus to ensure document compliance lies on the seller.

Let us see how the examination process takes place. Issuing bank will receive the documents by air courier. Upon receipt of the documents, the bank officer will retrieve the copy of letter of credit and conduct a document checking against the letter of credit. When the documents are found in compliance with the terms and conditions of the letter of credit, the applicant will be contacted by phone to notify the arrival of the documents. A good banker will send a SWIFT message to the sender bank to confirm that the documents are received and payment will be transmitted in accordance with the reimbursement clause. Consequently, a SWIFT message (MT202) will be effected to remit payment in the case where direct TT claim on the issuing bank is not allowed.

In this case, the charges incurred on phone and electronic fund transfers are debited to the applicant’s account.

The process does not change even if the documents are found to be discrepant. The bank officer must notify the applicant by phone, send a SWIFT message to the sender bank to notify rejection and reimburse the negotiating bank if the applicant accepted the discrepancy. The bank officer would not call the applicant 10 times to notify 10 discrepancies found in the documents or send 10 separate SWIFT messages to notify the sender bank of the discrepancies found in the documents. Only one phone call and one SWIFT message would put the examination process to an end. So, what is this ‘additional’ so called a discrepancy fee between USD20 to USD50 for?

If the objective of this fee is to curb or reduce discrepant documents, it has successfully proven that it failed miserably.

In view of the new UCP 600, the doctrine of strict compliance is seen going beyond 'strict' compliance and reaching the border of ‘substantial compliance’ as evidenced by article 14. From the bank’s point of view, the doctrine of strict compliance is no longer based on ‘mirror image’ but much wider. This indirectly means that the potential risks of wrongful rejection by the banks are higher. To mitigate these risks, banks eventually pass over the ‘non-mirror image’ documents to the applicant for final decision. The applicant will give a final say whether or not to take up the documents and convey the decision to the bank within 5 banking days.

Looking at article 16, it seems that UCP further reduces the risks of the banks by allowing the presenter to arrange how the discrepant documents should be disposed off. This article intentionally allows the presenter and the applicant to sort out the discrepancy problem. Not only the role of the bank has becoming lesser, but the risks in handling non-compliance documents are also reduced.

So, why would the presenter need to pay additional fee if it does not trigger any additional performance by the Issuing bank? What risk can possibly be reduced by charging a discrepancy fee?

Step To Mitigate Trade Risks

Since the establishment of the UCP, it has never been intentionally to address or mitigate issues on fraud. The primary purpose of formulating the UCP is to provide a set of uniformity governing the conduct of trade activity in commerce. It is aimed at ensuring smooth transition of goods, services and payment. As the life blood of commerce, money, regardless of currency is what the protection needed the most and not be compromised at any cost.

Article 4 and article 5 of UCP 600 formed what is known as the principle of autonomy where it is solely to protect the integrity of payment obligation by banks. In other words, it means the letter of credit only guarantees the payment provided that the terms and conditions of the credit are complied with.

But, what about the integrity of the beneficiary or seller? How does buyer establish the performance capability of the seller, credit standing, business history and other important aspects related to trade?

This is an issue which is not covered in the UCP and there are no official guidelines on how to go about in establishing the integrity of the seller especially when the seller is domiciled in different country.

The buyer is always advised to conduct independent checking through Chamber of Commerce or by obtaining confirmation letter from the seller’s bank before concluding any agreement. This method however, is not favourable by most traders as the turn around time to get a reply is considerably long and in most cases it is viewed as not practical. Not only time, but the genuineness and precision of information are also very important to buyers in making business decision especially in establishing a first time trade relationship. Replies received from banks in most cases are not helping the buyer in making business decision.

A reputable third party private company, American Heritage is a good source of obtaining information on companies registered in the United States. Buyers may easily access to millions of active company through their marketing list. Information like owner of the company, business type, branches, number of employees and others can be easily obtained from their mailing leads. Financial information on the other hand is available from their mortgage mailing list.

Although this may not provide a guarantee but, it gives a very good overview of who the buyer is dealing with and what is the next course of action to be taken.

Discrepancy In Commercial Invoice

The commercial invoice is the commonest document in international trade because nearly no letter of credit issued without stipulating an invoice. In most cases, commercial invoice is the only document which the beneficiary issues himself which is in accordance with UCP 600, article 18(a)(i), “…A commercial invoice must appear to have been issued by the beneficiary (except as provided in article 38).”

It is the primary document where it reflects out what the goods are in respect of which presentation is been made and it states the price which is being claimed in respect of them. It serves as an accounting document and documentary evident in which the seller declares that he has sold to the buyer, what he has sold and at what price he has sold.

With regards to the commercial letter of credit, an invoice is a specific document which is closely related to the goods/services, quantity and price. The “description” of the goods is normally the cause for discrepancy which resulted in rejection by banks. This is because most of the traders do not understand the implications of non compliance.

To describe details of the goods should not at all be a major problem because it should go according to what is already described in field 45A of SWIT format. It is as simple as copying the description in a letter of credit into an invoice. For example, if the description in field 45A states “Advertising balloons and advertising blimps: 100 sets of helium balloons, 150 sets of advertising balloons and 50 sets of advertising blimps”, the invoice should bear the same description.

However, article 14(d) of UCP 600 in a way, provides allowance to the beneficiary where the description of the goods/services need not be identical but must not conflict with any data in any other document called for under the letter of credit. But bear in mind, a slightest mistake which brings a different meaning and does not refer to the goods mentioned in the letter of credit or ambiguous description, it is deemed to be a discrepancy by the bank. Therefore, to avoid any unnecessary disputes later on, the "description" is best to appear as a mirror-image.

The description of the goods/services in Insurance Certificate or Bill of Lading for example, may be described in general and need not be exactly as what is described in the invoice or letter of credit. It can be as general as “Advertising balloons and advertising blimps”. On principle, all data contents in all documents and the letter of credit itself must not conflict with each other.

S.W.I.F.T

Society For Worldwide Interbank Financial Telecommunication or in short SWIFT is a private international telecommunication network which was established in Belgium in early 1970s and became operational on May 9, 1977. SWIFT however, is not a financial institution but provides telecommunication service for transmission of financial and non-financial messages to all member banks worldwide. SWIFT is solely a transporter of messages. It does not hold funds nor does it manage accounts on behalf of customers, nor does it store financial information on an on-going basis.

As a message transporter, SWIFT transports messages between two financial institutions. This activity involves the secure exchange of proprietary data while ensuring its confidentiality and integrity.By introducing IPSec-based security, a suite of protocols for securing Internet Protocols (IP) communications, SWIFT continues to maintain its leadership in providing the most secure financial messaging services.

Interested e-commerce community who wish to get connected with SWIFT may subscribe to their direct connectivity facility using SWIFTNet services. Before subscribing, it is advisable to access to web hosting articles to find out more information on various ranges of software and security features available in the market.

Web hosting articles provide good source of information for the public, particularly e-commerce community in obtaining a holistic understanding on how the electronic medium works in message transmission while at the same time maintaining the security that is the most important feature.

Every bank that subscribes to SWIFT is assigned with a Bank Identifier Code or BIC which is a unique code to identify each different bank. For example, RHB Bank, one of the anchor banks in Malaysia and a member of SWIFT is identified with the BIC, RHBBMYKL. When SWIFT sends any message to this BIC, it will reach RHB Bank head office in Malaysia. It works on a basic concept similar to an email address or domain name as explained in many web hosting articles over the internet. There are two types of BIC, 8 character BIC or known as "BIC8" and 11 character BIC which is known as "BIC11". A BIC8 identifies a financial institution in a country or a location whereas BIC11 identifies the financial institution’s branch.

Messages sent through SWIFT are formatted according to message type, for example, MT100, MT700, MT202, MT799 and so on. The format is arranged using a specific alpha numeric code to identify data like name of beneficiary, name of a bank, location, amount, sender and other related information. This will enhance the processing of different type of messages by member banks before transmitting them to their respective branches.

High-tech cargo theft

The transportation industry in the U.S is reported to be within the circa of USD2.7 trillion. This statistic represents 17 percent of the whole U.S economy. Out of this, it is reported that around USD30 to USD50 billion worth of cargo is stolen worldwide each year. This alarming figure demands a serious security measure to be integrated into the transportation and delivery processes especially when dealing with high-tech cargo, for example electronic devices. These items are essential in industrial automation and attract high demand worldwide in pursuing to lower the cost of production and enhancing operations.

Trading parties, therefore need to conduct due diligent on transport operators or forwarding agents before appointing one. This is important for both trading parties because the movement of the cargo from the point of origin to the final destination should be readily updated and accessible at any time to both parties.

The security measures increasingly critical when dealing with parties of different countries. For example, ABC Technology, a company located in Malaysia is buying solid state relays, electromagnetic relays and relay socket PCD from Mil-Com Components, a company domicile in the U.S. Even if the trade term CIF is agreed upon by both parties, the buyer still can make a suggestion to the seller, Mil-Com to appoint a well established transport operator which also has an office in Malaysia. Although, the obligation to contract for transport lies in the hand of the seller, but the buyer may determine which transport operator he is comfortable with.

However, there are many other aspects leading to loss of cargo or stolen cargo such as the spread of global crime syndicates where a new breed of smarter criminals able to adapt to the new technologies of the cargo transportation industry.

Scope of Cargo Insurance Coverage

The type of coverage that the insured can obtain ranges from the minimum cover provided by the basic policy commonly termed as S.G. Policy (Ships and Goods Policy) to the maximum protection of “All risks whatsoever”. The S.G. Policy covers the loss or damage to goods (total or partial) arising from the perils of the sea. As the goods in transit are exposed to other extraneous perils such as theft, pilferage, leakage, shortages, etc, the scope of the cover provided under the S.G. policy has to be enlarged by introducing a number of Institute Cargo Clauses (ICC) such as Free from Particular Average (FPA), With Average (WA) and All Risks (AR). Furthermore, certain types of cargo require special clauses, commonly termed as trade clauses e.g., Rubber Clause, Raw Sugar Clause and Timber Trade Federation Clause.

The All Risks Clause provides coverage for all perils, excluding losses or expenses proximately caused by delay, inherent vice or nature of the cargo. The coverage for shipments by air is as per the Institute Air Cargo Clauses (All Risks) (excluding sendings by post), which differs from the other clauses to cater for the particular need by the mode of transport. The important things to note is that these clauses are so designed as to provide cover supplemental to the basic cargo insurance policy (S.G. Policy).

It should be pointed out that due to difficulties encountered by the commerce and trade in the interpretation of the archaic wordings of the S.G. Policy, the Lloyd’s Underwriters Association, in consultation with the Institute of London Underwriters and other interested parties, has replaced the S.G. policy with a simple document and a corresponding set of a new Institute Cargo Clauses – ‘A’, ‘B’ and ‘C’ in place of ‘All Risks’, W.A. and F.P.A. Clauses.

Clause A covers all risks of loss or damage to the assured matter subject to the following exclusion:

Willful misconduct of the Assured; ordinary leakage, loss in weight or volume, wear and tear; unsuitable packing; inherent vice; delay; insolvency or financial default of owners, managers, charterers or operators of vessel; atomic weapons of war and radioactivity.

Clause B covers loss or damage to the assured matter reasonably attributable to the following risks:

Fire; explosion; stranding; sinking; grounding; overturning; derailment of land conveyance; collision or contact of vessel with any external object other than water; discharge of cargo a t pot of distress; general average sacrifice; jettison; washing overboard; entry of sea, lake or river water into vessel, craft, hold, conveyance, lift van or place of storage; total loss of package lost overboard or dropped during loading or unloading; and earthquake, volcanic eruption or lightning.

The exclusions under B clause are similar to those of Clause A with the addition of deliberate damage to or destruction of assured matter.

Clause C covers loss or damage to the assured matter reasonably attributable to the following risks:

Fire; explosion; stranding; grounding; capsizing of vessel; overturning; derailment of land conveyance; collision or contact of vessel with any object other than water; discharge of cargo at port of distress; general average sacrifice; and jettison.

The exclusions under C clause are identical to those of Clause B. In addition, the losses arising from the following risks are not covered:

1. Earthquake, volcanic eruption or lightning
2. Washing overboard
3. Sea, lake or river water damage
4. Total loss of any package lost overboard or dropped whilst loading on to or unloading from vessel.

The loss or damage caused by war and strikes, riots and civil commotion (SRCC) is also excluded under all the three clauses mentioned above. However, traders can obtain cover against losses arising from war and SRCC risks on payment of an additional premium.

It is important to remember that war risks are covered only when the cargo is water-borne that is it is not in force whilst the cargo is on land. The cover starts only when the cargo is loaded on board the vessel and ceases as soon as it is discharged from the vessel at the final port or after the expiry of 15 days counting from the midnight of the day of arrival of the vessel at the final port of discharge, whichever is earlier.

Basic Principle of Cargo Insurance

Cargo insurance plays an important part in facilitating trade transactions. Through cargo insurance, the financial losses suffered by traders on account of damage to goods in transit resulting from various hazards such as fire, storm, collision, stranding, theft, sinking, explosions etc, are transferred to insurance underwriters. By providing protection cargo insurance enables all those engaged in overseas trade to expand their operations.

There are five basic principles governing cargo insurance:
1. Insurable interest. Two conditions should be fulfilled to establish insurable interest, namely:
a. The person should have a legally enforceable financial interest in the property being insured.
b. He should be exposed to suffer a financial loss if the insured property is lost, damaged or destroyed.

2. Indemnity. This principle states that the assured should be restored as nearly to the same position after the loss, as he occupied immediately preceding it. However, in cargo insurance, it is a common practice to issue “agreed value” policies, e.g. 10 cases of milk powder valued at $5,000.00. This implies that all losses are settled on the basis of agreed value irrespective of market value. However, claims for repairs or partial replacements are paid on the basis of actual cost of repair or replacement subject to the limit of the sum assured.

3. Utmost Good Faith. Utmost good faith is the cardinal principle of all types of insurance. The assured must disclose and truly represent all material facts regarding the subject-matter of insurance, which he knows or should know in the ordinary course of business.

4. Subrogation Rights. This is the right of the insurer to take over the privileges of the insured to recover the loss from those who are wholly or partly responsible for it. For example, if the loss is caused by the negligence of the carrier, the insurer, under subrogation rights, is entitled to recover the loss from the carrier in the name of the insured.

5. Contribution. Where an insurable interest of property is insured by two or more underwriters covering the same risks, each has to contribute in the same proportion as the sum insured under his respective policy to the total amount of the loss. The insured may claim the total loss from any one of the insurers and the insurer, who pays more than his ratable proportion, can claim a contribution from the other insurers.

Part three: Responsibility of the issuing bank

The issuing bank, as mentioned in the previous post, is a bank which issues the LC at the request and on the instruction of the buyer. The issuing bank, in most cases is the bank of the buyer where he maintains banking relationships. Prior to giving the instruction to issue the LC, buyer and seller had concluded a sales agreement or contract and agreed to settle the trade payment using LC.

In the LC operations, other than the buyer, seller and issuing bank, there are other banks involved such as advising bank, nominated bank and in some instances, confirming bank. The issuing bank is the ‘anchor’ bank, the last bank in the line of banks, which holds the definite undertaking to pay and the final destination where the documents must reach, before they fall in the hand of the buyer.

The main responsibility of the issuing bank is to make payment, either directly to the seller or to reimburse the bank which had made the payment to the seller.

The seller, upon shipment of the goods, presents the documents to his bank. His bank may or may not pay him for the value of the documents depending on whether or not his bank is expressly nominated by the issuing bank to make payment. Even if his bank is expressly nominated by the issuing bank to make payment, this does not mean that his bank holds the ‘definite undertaking’ to pay. Meaning, his bank may refuse to pay and send the said documents to issuing bank for payment. Upon receipt of the same, the issuing bank will examine the documents to ensure compliance. When the issuing bank is satisfied, payment will be remitted for the credit of the seller’s account via his bank.

If, however, the seller’s bank agrees to make payment against the documents to the seller, the seller’s bank will credit the amount into his account. The documents than, will be sent to the issuing bank for final examination. Upon receipt of the said documents and in compliance with the terms and conditions of the credit, the issuing bank will remit the payment for the credit of the seller’s bank, being reimbursement of the amount paid to the seller.

In any event, either the nominated bank pays to the seller or not, the issuing bank must honour its undertaking to pay provided that the documents are in compliance with the terms and conditions of the credit. The issuing bank is also responsible to examine the document within the stipulated time to decide whether or not the documents are in compliance.

Risks mitigation

The question arises why contract parties are willing to pay so much money for bank commissions instead of paying directly to the other contract party. To give an answer to this question, it is first necessary to take a look at the risks of worldwide trade today.

Risks associated with trade

“The truth is that risk is a derivative, and essentially negative, concept – an elliptical way of saying that either or both of the primary obligations of one party shall be enforceable, and that those of the other party shall be deemed to have been discharged, even though the normally prerequisite conditions have not been satisfied.” (goode)

Business outside of the home country bears greater risks than inside; wide distance, different law and business practices, different currencies, different political systems and communication problems caused by different languages and technical standards are typical problems in international business. If contracts are ruled by foreign law, it is often hard to estimate the legal situation of the foreign contract party. Another problem is the performance of the contract; matching payment with physical delivery is not possible, therefore also no control. To take a party to court can be difficult because of foreign language, foreign law, foreign process law or the need of a foreign solicitor. There are mainly four risks to face when trading worldwide: economic risks, political risks, payment risks and transport risks.

Economic risks

Economic risks results from a lack of quality, solvency or credit-worthiness of a contract party. Exporter’s risks are the manufacturing risk, that means that the importer could get insolvent or breaches the contract while producing the goods; the risk that the importer do not take the goods delivered, and the delcredere risk, which means that the importer do not pay, for example because of delay or unwillingness or incapability to pay. In a wider sense, economic exporter risks are includes the risk of bankruptcy of the importer, the risk of arbitrary cancellation of the contract, the risk of compositions / arbitration or the risk that an execution does not compensate a payment claim. But there are also importer´s risks: the order risk, that means that the exporter cannot deliver promised goods, and the delivery risk, which means that the exporter fails in performance caused by delay or lacks in kind, quality or quantity of the goods.

Political risks

Political risks, also called “state risks”, are caused by measures of governments or authorities or are results of war, rebellion or revolution. These risks can concern goods, which can be confiscated, expropriated, destroyed or damaged, or can concern assets or payments caused by confiscation, prohibition of payment, a moratorium or restrictions of conversion or transfer of money. Perhaps each party wants to perform, but caused by such political circumstances that is impossible. In some cases, for example war, the whole contract is regarded as being frustrated if one of the parties acquiring the status of an enemy. Or the performance can be disturbed by war.

A contract can also regarded as frustrated if legislation of one country after conclusion of it prohibits its performance by placing an embargo. An important and usual risk is the risk of a moratory; a state prohibits payments because of the incapability of the state to pay.

Currency risks

Currency risks are caused by floating exchange rates of the home currencies of each party and generally include the danger of losses. The exporter who signs a contract which includes payment in foreign currency bears the risk that he receives less money than he has calculated. The importer who has to pay in foreign currency bears the risk that he has to pay more money for buying foreign currency than he has calculated. Such currency risks can be caused by economical and / or political reasons. Another risk occurs if the currency of a state is not convertible or payments in this currency are not allowed. Even this is more a political risk, caused by measures of a state, it can also include a currency risk if the payment was said to be made in this currency.

Transport risks

Import and Exports include a transport risk; goods can get lost or damaged on the transport way. The question arises from which point on the importer has to bear a risk and has to pay even he never received goods. Another problem occurs if the property in the goods has passed, but the buyer justifiably rejects the goods; it is then not always clear who has to bear the risk of any loss, damage or deterioration of the goods if they must be stored or transported back.

Letters of credit can be used for risk-minimization of some, but not all of the above mentioned risks.

Italian court decision: Strict compliance

In general, the Italian approach of “facial” compliance obliges the bank to check the documents only externally to determine whether they comply with the terms and conditions expressed in the credit. The documents may be accepted legitimately if the bank determines that any formal discrepancies are irrelevant to the validity of the credit. Additionally, the bank is not responsible for the discrepancies in the documents if these irregularities cannot be detected during formal examination of the documents. The bank is not required to perform an exhaustive examination of the documents, but this check, though limited and external, must be extended to anything that would be immediately apparent upon examination. The following are some decisions of Italian courts from the early 1950s to the late 1990s that show how the strict compliance doctrine has been approached over the years.

Decision: Credito Italiano v. Banco di Sicilia,

Corte di Appello di Palermo – July 30, 1951
Corte di Cassazione – October 17, 1953

Initially, Italian jurisprudence favored the doctrine of strict compliance. More recently, however, Italian courts seem to prefer the “reasonable approach,” thanks to a decision of the Corte di Cassazione in 1953, which held that the bank’s examination of the documents must be intelligent, not automatic and that it must be based on a reasonable standard.

The case before the court dealt with the responsibility of a bank which, in a letter of credit transaction, paid the beneficiary upon presentation of documents that were not in conformity with the credit. There was a discrepancy between the letter of confirmation issued by the confirming bank and the certificate of analysis of the alcohol content of Marsala wine tendered by the beneficiary to the bank as part of the documents of the credit. The confirmation letter referred to the same terms as the purchase order issued by the customer to the beneficiary (the order referred to a certain amount of Marsala wine having a general alcohol content of seventeen percent), whereas the certificate of analysis specified an alcohol content of seventeen percent “al piccolo Malligand.”

The lower court held that the documents tendered by the beneficiary were formally regular. Nevertheless, the case was brought in front of the court of appeals. The claimant, Credito Italiano, asserted that the term specifying that the Marsala wine was of seventeen percent “piccolo Malligand” implied not just a formal discrepancy in comparison to the order (which referred simply to Marsala seventeen percent), but also a substantial discrepancy, because the generic indication of alcohol content included in the order should use only the measurement system recognized by law, that is, measurement of alcohol content by volume. On appeal, the court held that the discrepancy was irrelevant, and that the acceptance by the Banco di Sicilia of documents referring to “Marsala wine [seventeen] percent al piccolo Malligand” could be considered irregular only if the specific measurement method was not adequate to measure the alcohol content, which was not the case. The duty of diligence of the banks was limited to the mere control of the formal regularity of the documents. A mere literal discrepancy between the description of the goods as contained in the documents tendered by the beneficiary and what was requested by the buyer does not make the payment by the bank irregular if the descriptions in the two sets of documents can be considered equivalent.

The court of Cassazione confirmed the holding, asserting that even if the method of analysis (the “volume” method versus the “Malligand” method) was not suitable for correct measurement of alcohol content, it was not acceptable for the bank to refuse documents and payment on the ground of such a discrepancy between title and document. In other words, what is required of banks in verifying documents is a standard of reasonable care (una media ragionevole cura), for instance the diligence of an average, diligent bank employee, which has nothing to do with an analysis of the merits of the document’s substance. The court explained further that the bank’s duty is limited to that which is within the capacity of the average diligent bank employee who cannot be required to demonstrate specific knowledge in technical fields beyond his competence and expertise in the performance of his job. Both the appellate court and the court of Cassazione confirmed the acceptance of the documents and rejected the claimant’s request.

The International Standard Banking Practice (ISBP) issued by the International Chamber of Commerce states that documents presented under a letter of credit must not be inconsistent with each other, meaning that the data do not need to be identical, merely that the documents shall not be inconsistent. Thus, the decision of the lower courts, confirmed by the court of Cassazione, can be considered in compliance with the ISBP. The two documents (the confirmation letter issued by the bank following the client’s purchase order, and the certificate of analysis) are not inconsistent with each other. They are not identical, but a “mirror image” is not required.

Insurance And Cargo

Question from Mr. Abdul Majid, Pakistan:

Is it important to pay insurance for export of rice ?

I believe you are looking at the point of a seller or exporter, and whether or not a seller should take up cargo insurance when exporting rice. I would rather share an open ended comment.

One of the most important aspects on which the Insurance works is called "insurable interest". In layman term, it means you will either benefit financially from their safe arrival at the point of delivery OR you will lose out in the event of loss, delay or damage. Keyword here is "losing out in the event of loss, delay or damage". The events leading to loss, delay or damage to the goods are uncertain, they may or may not happen. Mostly are out of our control, like fire, war, accident, negligent, act of God, riot, theft, default, perils, etc. The fact remains, the possibility of any of these factors to happen is ever present.

The Hague-Visby Rules, article 4, clearly indicates disclaimer on the part of the carrier with regard to the loss of, damage or delayed to the goods. The liability of the carrier is very limited. It simply means, in the event of mishap, you would not be able to recover the value of the goods, you lost the cargo, capital and profits.

Now, the question is, it doesn't matter what goods you are exporting, are you willing to lose your cargo, capital and profit? Can you afford it? All the times?

Incoterms 2000 however, does not indicate "obligation" in A3 & B3 (Contract of Insurance) both for buyer and seller for all trade terms except CIF and CIP only. Buyer does not owe a duty to seller to procure insurance for his own benefit and vice versa. It is clearly not an obligatory, but this does not mean insurance is unnecessary. Of course insurance is an 'additional' cost which does not add value to the goods and considered 'gone' payment. But in the event the mishap happens, it makes a lot of different between gone and gain.

Principle of Autonomy

If the seller ships the goods which are not up to the buyer’s expectation, can the buyer get the bank to cancel payment under LC? For example, the letter of credit says, ‘milk powder grade A’ but seller shipped ‘milk powder grade B’. Can the buyer instruct his bank to stop payment of the LC which has been issued to the seller?

Letter of Credits are separate contract from contract of sale and other contracts existing which bind the parties involved in an international trade transactions. This is clearly stated under article 4 and article 5 of UCP600. LC is only concern with payment and absolutely has nothing to do with goods.

The dispute in any of these contracts shall not form grounds for non-payment of an LC. Regardless of any disputes, seller is still entitles to payment under LC. Disputes between parties should be settled by litigation or arbitration or otherwise as stipulated in the contract. This principle is clearly emphasized in one of the popular cases, Hamzeh Malas & Sons v. British Industries Ltd.

The plaintif, a Jordanian firm, had contracted to purchase from the defendant, a British firm, reinforced steel rods to be shipped in two instalments. Payment was to be effected by way of two LCs. The first instalment was delivered and payment was obtained by the seller. The plaintiff then complained that the first instalment was defective and sought to enjoin the defendant from drawing under the second LC.

The court commented:

“…the opening of a confirmed LC constitutes a bargain between the banker and the vendor of goods, which imposes upon the banker an absolute obligation to pay, irrespective of any dispute there may be between the parties as to whether the goods are up to contract or not…A vendor of goods selling under the insurance that nothing will prevent him from receiving the price…”

Based on the judgment passed by the court of law, it is important to understand that in LC transaction, payment is 100% guaranteed but it is not an undertaking to guarantee the goods.

Doctrine of strict compliance

If the problem of interpretation of strict compliance is regarded from importer´s, exporter´s and banker´s view, it will lead to different results. The interest of the exporter can be easily determined: he wants to receive payment against the documents, even there are (relevant) mistakes.

So, an exporter will plead for the substantial compliance which offers more tolerances to him. A bank is interested to receive its charges and commissions without or with little risk. On the other hand, it must keep its reputation which can hardly been reached if every irrelevant mistake will lead to an obligation to refuse payment.

So, the interest of a bank is to make decisions on its own. For it, the literal compliance in a wider sense offers the best possibilities: obvious typographical errors do not lead to an obligation to refuse; on the other hand it can refuse payment in cases of doubt and is not obliged to examine the documents materially or finds itself as an arbitrator between applicant and beneficiary with the risk that it pays, but is not reimbursed and must lead a process.

Regarding the importer, it is not easy to say what interpretation of strict compliance he would prefer. Of course, he would not prefer the substantial compliance because it would lead to additional risks for him if his stipulations were not exactly fulfilled and the bank took up the documents in the belief that they are substantial equal. In such a case, a huge process risk would occur for him if he refused to pay the bank. But also it is not quite clear if the strict literal compliance offers more flexibility for him: the chance to give instructions to the bank if there are typographical or irrelevant errors make it possible to exploit the situation and claim new negotiations about the price with the beneficiary.

On the other side, a situation can occur when a bank has got own interests like financing the goods by credit: in such a situation, exporter and importer perhaps both want the sale contract to be fulfilled even there is an irrelevant error, but the bank refuses to pay because for example, the interest rates for a credit have been raised or because the credit-worthiness have been changed. So it is more secure for the importer if strict compliance is interpreted as wide literal compliance.

Some of the technical problems

If exporter load the container after “latest date of shipment” but within the expiry date and also submit the documents before expiry of 100% sight Letter of credit, what is the security of exporter shipped consignment amount is he secure?Is it possible importer quit the L/C?


Shipment made after the latest shipment date indicated in the LC is considered a discrepancy, which is late shipment. In this regards, bank will refuse payment. When bank refuses payment, normally, the issuing bank will notify the buyer whether or not the buyer will accept the rejected documents. If, subsequently the buyer accepts the rejected documents, bank will effect payment. I don’t get the meaning of ‘quit’. If it means cancellation, it is not possible for the buyer to cancel the LC if it is an irrevocable LC. But, if it means ‘reject’, yes the buyer may reject the documents and shipment. When this happens, the bank will return the documents to the seller. The seller has to arrange to dispose the cargo to another party.

Second condition is that in the L/C partial shipment allowed and importer paid one container payment. Is it possible importer quit another container and doesn’t not collect the documents therefore his bank received the second container documents.3- If in L/C partial shipment allowed exporter sends the 1st container and also send documents to his bank is it possible he collect the documents and get this container, other container on transit.

If either party would like to cancel the irrevocable Letter of Credit, he must obtain a consent form the issuing bank, confirming bank (if any) and trading party. The issuing bank, having issued the LC is bound to honour its payment undertaking whether or not the goods are in conformity to the Sales contract.

Characteristics

Credit function

The documentary credit, even it contains the word credit, is no credit in the sense of law, but still today in times of strict separation in law exists an important economic connection between letters of credit and credit transactions. Both, importer and exporter possibly needs financing for buying or producing goods, and both can be debtors or creditors to each other regarding the terms and conditions for payment. But also the banks which are involved in the letter-of-credit-transaction can be creditors next to the letter of credit.

The issuing bank could finance the price of the goods and receive the money back after sale of the goods in the home market of the importer. The bank of the exporter on the other side could finance the production of the goods in the expectancy that it receives the money back after handing-over of the documents.

A documentary credit makes it easier for banks to finance goods. In the case of an acceptance letter of credit, when a draft was signed by the issuing bank, the exporter can also sell this bill of exchange at a discount to a bank and receive immediately money instead of waiting. He needs not to finance over a long period.

Security function

If there is no reliance between exporter and importer, if they do not know each other, the seller requires security for payment. It is hard possible to claim the payment in the state of the importer.

A letter of credit is called “child of distrust between seller and buyer”. It secures the change of the performances of buyer and seller. The importer can be sure that the exporter only receives a payment if he proofs his delivery in accordance with the contract through handing-over of documents to the bank and the exporter on the other side, can be sure that he receives payment if he handed over the documents.

The contract parties are secured against solvency risks of the other side because the letter of credit makes it possible to match payment with delivery what else would be impossible. There is nearly no economic risk for the exporter. The stipulated documents can be a security for financing banks because the goods are at their disposal. In the case of an acceptance credit, the exporter can not only rely on the reputation of the bank and its promise to pay; a bill of exchange is also independent from other contracts and offers therefore and because of its binding to strict forms and rules security. The bank, if it financed goods for the importer, receives by the documents the shipped goods as security. If a letter of credit lapsed because of wrong documents or documents not presented in time, the seller could still insist on payment because of the sale contract.

A letter of credit is a second performance additionally, but not instead, of the first one. Some political risks for the exporter can be avoided by an irrevocable, confirmed letter of credit. Measures of government like a moratorium or restrictions in conversion of currency in the importer´s country do not cause losses to the exporter if he can claim payment from a bank in his own state. Currency risks caused by governmental measures can be reduced if the letter of credit is issued in a free floatable currency.

But of course, letters of credit cannot avoid of all risks: transport risks can be covered by special transport insurance, currency risks resulting from floats can be avoided with special bank transactions on the currency market like derivative currency transactions, for example swaps or currency options. Also it is possible to fix the currency rate in the contract.

One of the main risks a letter of credit cannot avoid is that a fraudulent seller delivers documents which appear clean, but delivers rubbish or goods not in accordance with the contract.

Beneficiary's veto power?

Compliance documents or now known as compliance presentation is still be the nucleus in making a payment by banks. Article 2 states that “…Credit means any arrangement, however named or described, that is irrevocable and thereby constitutes a definite undertaking of the issuing bank to honour a complying presentation”

Undertaking of the bank to pay is absolutely based on documents that comply with the terms and conditions of the LC. It is therefore, an obligation of the banks; the nominated bank, issuing bank or confirming bank, if any, to examine and check on the basis of the documents alone, whether or not they appear on their face to constitute complying presentation. This includes type of documents, number of copy, original or photocopies, issuer of a document as well as the data in a document to ensure they are consistent with each other and not to conflict with the LC. However, this does not include documents presented but not required by the LC.

What happens when the presentation is found not in conformity?

Article 16(a) says that “…when a nominated bank acting on its nomination, a confirming bank, if any or the issuing bank determines that a presentation does not comply, it may refuse to honour or negotiate”.

Article 16(b) further states “when an issuing bank determines that a presentation does not comply, it may in its sole judgment approach the applicant for a waiver…”

In the event the documents are discrepant, the bank can either:

1. refuse to take up the documents or;
2. refer to applicant for a waiver

These two options are still maintained in UCP 600 and has been the practiced for banker worldwide. What UCP 600 differs greatly from UCP 500 is the manner of refusal of discrepant documents (article 16(c)(iii)(b)).

Previously, in UCP 500, refusal of discrepant documents should not be subjected to or pending acceptance of a waiver from the buyer. This was not construed as a refusal. Refusal of this manner is considered as a bad practice and strongly discouraged.

However, drafters of UCP 600 now has interpreted differently where refusal of discrepant documents can be subjected to or pending acceptance of a waiver from the buyer. Not only this, the seller, now is given the privilege to issue instruction on how the documents should be disposed off (articles 16(c)((iii)(a), (b) and (d)). It is understandable, after going through all the articles in UCP 600, it is drafted with a main focus given to the users; traders, transport operators, insurance companies etc. with a view to reduce discrepant documents and upholding a concept of ‘payment mechanism’ of the LC. This article in particular, is seen to provide a safety cushion and more comforting to the seller instead of the buyer.