Examination of documents under LC

The principle of strict compliance is ruled by articles 14, 15 and 16 of the UCP 600. Article 14(a) obliges the bank to examine all documents stipulated in the credit to ascertain on the basis of the documents alone, whether or not they appear, on their face, to constitute a complying presentation. That is in compliance with the terms and conditions of the Credit. Compliance of the stipulated documents on their face with the terms and conditions of the credit shall be determined by international standard banking practice as reflected in the UCP 600. Therefore documents which appear on their face to be inconsistent with one another will be considered as not appearing on their face to be in compliance.

That standard is applicable only for stipulated documents; documents which are not stipulated will not be examined and shall be returned to presenter or be passed without responsibility. Banks shall have reasonable time for examination, not to exceed five banking days following the day of receipt of the documents, and for determination whether to take up the documents or to refuse payment. Banks will deem conditions as not stated and disregard them if a credit contains such conditions without stating the documents to be presented.

Banks, which can be the issuing bank, the nominated bank or the confirming bank, must determine of the documents alone whether or not they appear on their face to be in compliance with the terms or not. If they appear not to be in compliance, banks may refuse to take up the documents. The bank hereby has got latitude when judging, which it need because not every error leads to a rejection and many problems can be solved by communication between bank, applicant and beneficiary. But the bank is obliged to decide on its own. If the issuing bank determines documents to be not in compliance, it may in its sole judgment approach the applicant for a waiver of the discrepancies.

Article 16(f) rules that if the issuing or the confirming bank fail to act in accordance with the provisions provided for in Article 16, they shall be precluded from claiming that the documents are not in compliance with the terms and conditions of the credit.

The issuing bank and a confirming bank are not relieved from any of their obligations or provisions of article 16. Banker´s examination consists of three steps:

the completeness of the stipulated documents,
the compliance on their face and if they are in accordance with each other and
the terms and conditions of the letter of credit.

Documents are complete if all stipulated documents are presented and if each document contains the stipulated number of duplicates. The compliance ‘on their face’ means that there must not be obvious falsifications and errors. The documents are in accordance with each other if they do not contain contradictions.

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.

Problem concerning 'strict compliance'

Literal compliance
Literal compliance generally means that the terms and conditions of the letter of credit must be fulfilled “literal” letter by letter. The bank is obliged to act within the frontiers of the given, formal and precise banking commission because the underlying sale contract between applicant and beneficiary lies outside knowledge and judgement of the bank. Where a bank receives the documents with a request for payment, it pays at its peril against documents which do not comply exactly with the terms of the credit.

Strict literal compliance
A first opinion interprets strict compliance in a strict literal sense: The bank has discharged its duties when it “has ascertained that, within the scope of the documents, all the necessary “i´s” are dotted and all the “t´s” are crossed, but on the other side it is not the bank´s concern if the appearance of compliance masks, some fraudulent dealing. Banks acting as they should under the doctrine of strict compliance may sometimes be criticized by their customers for being too ambitious when pointing out discrepancies of no or little relevance, but this would be an unavoidable consequence which follows from the nature of the service.

In most cases, it would be possible that the bank can ask the customer for approval; if there is no time for communication, a bank can still pay under reserve which would make it possible for the bank to claim reimbursement in case of a relevant discrepancy. To examine the documents “on their face” would have the meaning that banks are obliged to a formal examination of obvious discrepancies, but not to control if there are material discrepancies. Even a hyphen can lead to different interpretations. In other words, even the smallest discrepancy would not be tolerable because the bank cannot judge if such a small discrepancy can lead to enormous damages.


Wide literal compliance
Another opinion demands a wider compliance: where it can be shown that the supposed discrepancy results from a patent error, it would be unrealistic to treat the entire tender as invalid by reason only of a technical slip or mistake. To treat any typographical error or patent mistake as a discrepancy would convert the commercial transaction covered by the letter of credit into a proof reading exercise.

The kind and relevance of the mistake is therefore decisive, but not only if there is a mistake which is perhaps irrelevant for all parties. A discrepancy may not affect the value or merchantibility of the goods, and may thus appear merely technical. In such a case, a bank would nonetheless be obliged to found the documents acceptable. If a bank was obliged to ask the customer for approval even in obvious cases, a situation could occur where the customer tries to exploit the situation by requesting a discount of the price or other benefits from the seller. But a discrepancy must not be an emergency exit for buyers who regret their decision to buy. Therefore the bank must decide. In cases of obvious typographical or irrelevant errors it should be obliged to take up the documents.

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.