06 December 2007

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.

04 December 2007

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.

01 December 2007

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.

FOB and Cargo Insurance under LC

Question from Indian trader:
Insurance is a must why? To whom it is necessary? But sometimes the seller may feel that for FOB shipments,their responsibility stops on shipping the goods: This is not so,business should be a continuous process with another trader: If there is any negligence on the part of the buyer.It is prime responsibility of the seller to insure the goods: he can inform this and get the small amount from the buyer.
I don't quite get what you want to say. But I believe that you are saying the seller should take up cargo insurance if there is a negligent occurs on the part of the buyer.
First and foremost, in actual fact, transfer of risk from seller to buyer starts before the goods pass the ship's rail and on board the vessel or before the delivery point. If the buyer fails to arrange the vessel on the date and time as agreed, where seller is unable to load the goods, the risk passes to the buyer.
Secondly, buyer is also to bear the risk from the point of delivery onwards. On both situations above, buyer is said to have an "insurable interest" to the goods. Therefore, it is necessary for the buyer to procure cargo insurance even though it is not obligatory.
The question is, can the seller procure the cargo insurance for the benefit of the buyer on both situations above? Or can the seller take up cargo insurance for the benefit of the buyer under FOB?
Of course yes. The seller can also take up cargo insurance for the benefit of the buyer PROVIDED that the local law in both countries permit it. Both parties may agree on this arrangement and it must be precisely and expressly stated in the sales contract. This also applies to contracting a vessel. This however, does not change the important features of FOB term. It cannot be termed as "FOB+I" or any other weird terms just to signify that seller is to procure the cargo insurance. Under this situation, seller is not under obligation, but merely offering an ADDITIONAL SERVICE to the buyer. The accountability and responsibility to procure cargo insurance under FOB, still lies on the buyer.

Basic Operations

The documentary credit is the “traditional form of letter of credit created as a payment and financing mechanism for international sale of goods”. A typical documentary credit operates in the following way.

Suppose a seller in Malaysia wishes to sell some goods (e.g.: Palm Oil) to a buyer in Russia. Suppose further that the parties have not previously entered into any business relationship, thus they do not know each other. Although both parties are willing to enter into a relationship, they are very concerned about the other party’s financial reliability.

The seller wishes to get paid as soon as he has shipped the goods. He is afraid that, after shipping the goods the buyer may refuse to pay the purchase price, or even become insolvent. In both cases, the seller may have to engage himself into lengthy negotiations, or sue the buyer to seek enforcement of payment by the court, which will certainly incur great expenses. Not to mention the costs of shipping back the goods or storing them in the original country of destination until further actions.

On the other hand, the buyer is concerned that he may not get the goods in the agreed quality and/or quantity, thus he is not willing to pay unless he inspects the goods.

In a situation like this, where the buyer and the seller are distant from each other and transportation of goods is inevitable, it is impossible to have the seller paid upon shipment and at the same time allow the buyer to pay only upon inspection of the goods.

When difficulties such as distance, different currency (fluctuation of currencies), culture and foreign laws have to be dealt with, the parties are most likely willing to fall back on legal instruments, which reduce the risks both seller and buyer have to face in an international sale of goods.

One of these instruments created by the international trading community is the commercial letter of credit. By agreeing to a commercial letter of credit the parties invite a third, trustworthy party – a bank – into their relationship. Upon the buyer’s request, the bank will open a letter of credit in favour of the seller, agreeing “to assume the primary, direct and independent obligation to honour the seller’s draft presented under the letter of credit provided that complying documents specified in the letter of credit are tendered”.

This way the seller is assured that he will receive payment from an individual “paymaster” regardless of the financial situation of the buyer. On the other hand the buyer is also assured that payment will only be effected if the conditions, set by the buyer and appearing in the credit, are completely fulfilled.

In a basic letter of credit transaction three parties are involved: the buyer (usually referred to as the “Applicant”), the bank and the seller (usually the “Beneficiary”).
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