Doctrine of separability

One of the primary functions of the letter of credit is to create an abstract payment obligation independent of the underlying contract of sale and the contract between applicant and bank; therefore the conditions of the bank’s duty to pay are exclusively to be found in the terms of the letter of credit and the right and the duty to make payment do not in any way depend on the performance of the seller’s obligations under the contract of sale. The reason for this doctrine is that the bank should not become a kind of arbitrator to resolve disputes between seller and buyer which would lead to extensive delays of payment and would make the letter of credit unattractive as service.

It is essential that the doctrine is scrupulously observed; else the continuance of the documentary credit system as the primary means of payment in international trade would be in danger. When examining the documents, the bank does not examine the quality and quantity of goods. To judge what the documents contain or if the documents are economically plausible is not possible for the bank resulting from a lack of knowledge. Article 4 of UCP 600 explicitly forbids the bank to do so.

LC: Negotiation under reserve

Negotiation under reserve is sometimes resorted to by a bank only when it is convinced that the nature of discrepancies are not of any serious consequences and which in the bank's experience have not materially affected the LC terms but would nevertheless negotiate the documents under reserve. At the time of making payment under reserve, both the negotiating bank and the seller believe that the documents will be taken up by the issuing bank despite the discrepancies. The negotiating bank will draw the attention of the issuing bank by listing all the discrepancies on the remittance schedule. If, however, the documents are rejected, the seller will reimburse the bank for the amount and the interest from the date of negotiation to the date of repayment.

Nevertheless, the fact remains that the documents are not in complete conformity with the LC. A bank makes payment under reserve only to a seller who is a valued client of the bank and whose integrity is beyond doubt. By understanding all types of negotiation (without recourse, with recourse, against indemnity & under reserve), I hope all traders are aware of the risks and the roles of buyer, seller as well as functions of the issuing bank and negotiating bank in LC operations.

LC: Negotiation against indemnity

In LC operations, the seller is entitled for payment only against documents in strict compliance of the terms and conditions of the LC. This is the basic principle on which the LC operates. But, it often happens that the documents tendered are not always in conformity with the terms and conditions of the LC. According to a study conducted by the International Chamber of Commerce (ICC), Banking Commission, it shows that two-thirds of presentation of the documents against LC deviate from the terms and conditions of the LC on first presentation. Under this situation, negotiating banks may decide whether:

• to refuse the request for payment by the seller
• to pay under reserve to the seller
• to pay against indemnity from the seller.

It is easy for a bank to refuse to pay against non-confirming documents but this will have negative consequences especially if the seller is a valued customer of the bank. Therefore, banks do negotiate documents against an indemnity from the seller. The bank's decision to negotiate the documents against an indemnity is dependent mainly upon evaluation of the credit risk of its customer. When negotiating documents against indemnity, the discrepancies in the documents are listed in bank's standard indemnity form and executed by the seller. By doing so, the seller has full knowledge and aware of the discrepancies, possibility of rejection by the issuing bank and his obligation to refund the negotiating bank in the event the issuing bank refuses to take up the documents and pay the negotiating bank.

LC: Negotiation with recourse

If the seller presents the documents to his bank, which is not the issuing bank and also not the confirming bank, then that bank negotiates the documents with recourse to him. This is because the seller's bank does not hold an undertaking to pay even though it is authorized to negotiate the documents.

The seller's bank on the other hand, may refuse to negotiate or give value of the documents to the seller. The principle of negotiation with recourse arises in a situation when:

• the negotiating bank is not able to obtain reimbursement from the issuing bank or from the applicant, that is the buyer because they have become insolvent
• rejection of documents as a result of discrepancies in documents for which the negotiating bank is either holding an indemnity or has negotiated under reserve.

It is a norm within banking industry worldwide that banks other than confirming bank, upon receipt of the documents from the seller, would redirect the said documents to the issuing bank for payment. Once the documents are found to be in order, the issuing bank will reimburse the negotiating bank and the seller will be paid. This may take some time before the seller could get his payment because the payment is made by the issuing bank in the country of the buyer.To cut short the traveling time of the documents as well as to avoid negotiation with recourse, the seller could ask for confirmation to be added to the said LC. By doing this, seller is entitled for his payment by tendering the documents to the confirming bank in his country.

LC: Negotiation

Negotiation means the standard procedures that bank performs which includes checking of the documents and giving value to the seller. The issuing bank may issue the LC available by negotiation with a nominated bank or it may allow the LC to be freely negotiated with any bank.

In the first case, the beneficiary, that is the seller, has to present the documents only to that bank, which is the nominated bank. Nevertheless, the nominated bank is not bound to negotiate if it has not undertaken a separate payment obligation to the seller. The nominated bank may simply refuse to negotiate the documents drawn under the LC. This is because, by having been nominated by the issuing bank, it does not constitute and undertaking to negotiate. If, however, the nominated bank has added its confirmation to the LC at the request of the issuing bank, thereby undertaking a separate payment obligation to the seller, then it has to honour its undertaking and pay for the documents drawn under the LC if they are in order . LC which does not nominate any bank is normally available for negotiation with any bank in the country of the seller which is willing to negotiate the documents. For the information of all traders, there are 4 types of negotiation practiced by banks around the world. They are:

1. Negotiation without recourse

2. Negotiation with recourse

3. Negotiation against indemnity

4. Negotiation under reserve

Let me explain Negotiation without recourse first and the rest at a later posting. A seller may present his documents drawn under LC directly to either:

a) The issuing Bank (bank that issues the LC) or

b) The confirming bank (bank that adds its confirmation at the request of the issuing bank) or

c) To his own bank

If the seller chooses to present the documents directly either to the ISSUING BANK or to the CONFIRMING BANK, these banks make payment WITHOUT RECOURSE to him. Meaning, the payment that has been paid to the seller shall not in any way become claimable by these banks in the event the documents are found not in order after making such payment. These banks cannot have recourse to the seller because by issuing or confirming the LC, they have taken upon themselves the risk that the party from whom reimbursement is to be obtained may become insolvent.

I hope this would give traders a general idea of how the LC operates and the implications to buyer and seller.

Discrepant documents:Rights of the bank

I'm quite sure that all members have fully understood what LC means and how it operates in international trade. All members are also savvy of what seller and buyer should do when LC is used as a method of trade settlement.

What will happen if the seller tendered discrepant documents to the bank? According to studies, discrepant documents consist of 60% of the total documents tendered under LC worldwide. It simply means that, majority of documents handled by banks are discrepant documents. I personally have handled hundreds of thousand of them.

Under UCP 600, the Issuing bank has the absolute right to reject and refuse payment when documents are found discrepant, without prior reference to the buyer as per article 16(a) UCP 600. This means, the bank will list down all discrepancies, indicate statement of refusal and send it to the seller's bank via SWIFT MT734 format. The documents will also be returned to the seller's bank. End of the process.

When seller tenders discrepant documents, he locks dead the situation, he would not get his payment and the buyer on the other hand, would not get the shipment. In this case, the bank is the only party who can unlock this grave situation.UCP 500 article 16(b) permits the Issuing bank to seek for waiver from the buyer whether or not the buyer agrees to accept the discrepant documents.

Bear in mind that seeking for waiver or obtaining agreement to accept the discrepancy from the buyer is not an obligation on the part of the Issuing bank. This clearly indicates that the best way to avoid further risk to the bank is to reject and refuse the payment. This is the first priority for the Issuing bank.

I personally, during my career, always seek for waiver from the buyer. I mean all the time, whenever I received a discrepant documents. The main reason for doing this is because of the purpose and function of the LC itself. It is very clear that the LC is an instrument of PAYMENT.

Secondly, the main considerations in trade are payment and goods. Buyer is absolutely in need of the shipment. The moment the Issuing bank issues the LC, it signifies the intention of the buyer to purchase and to pay. When seller tenders the required document, he agrees to accept the payment. So, in most cases, payment is still be made. But of course, when buyer accepts the discrepant documents, it must be accompanied with an indemnity because who knows what lies in the container at the port.

Having said this, it doesn't mean that seller is permitted to tender discrepant documents. The right of the bank under this situation is to reject and refuse the payment.

Discrepant documents

I have two shipment from Shanghai to UK, both of them LC at Sight, Now I shipped both shipment to the UK at once. I just afraid if he refused to collect the documents, then how I can collect the payment or What I can do in the next term. Should I need to collect the cargo back? this is will let me loose lot of money in the freight which I already paid and getting back means again I need to pay the freight and taxes & duties. then what is the best way I need to adopt in such kind of situation. please mail me if you have any suggestions. kind regards.

Firstly, both of the shipments are under LC. Therefore you need not worry about the payment as long as you tendered the documents in accordance to the terms and conditions of the LC even if the goods are shipped on the same vessel.

Secondly, if you are sure the documents are discrepant, than you may communicate with the buyer with the view to amend the LC. However, this method may not be favoured by the buyer as he may not have sufficient time to do so. This would also mean that the buyer incur additional cost.

Other than this, you may request your bank to send the documents under protection to the Issuing Bank. If the documents meet the approval of the Issuing Bank, payment will be made in due course.

Alternatively, you may request your bank to communicate to the Issuing Bank the discrepancies and inquire if the Issuing Bank is willing to take up the documents before the documents are sent to the Issuing Bank.

However, if the Issuing Bank refuses to take up the documents and the buyer does not agree to waive the discrepancy, you have to arrange the goods to be sold to other party either in your country or in another country. Of course, this would incur additional costs.

Get in touch with your carrier on how to dispose the goods effectively.