30 December 2007

LC SWIFT Format: Field 20 (Documentary Credit Number)

Next MT700/701 field is field 20, Documentary Credit Number. This field is a self explanatory field. Every LC issued by the issuing bank must bear an ‘identity’ which is recognizable by the LC number. This LC number is a unique number assigned to an LC where every LC issued bears a different LC number.

LC number or identity is normally computer generated or in some banks the number is manually assigned by the issuing bank. It is a combination of alphabet and numeric characters subject to a maximum of 16 characters. The presence of this field is mandatory.

This number will be used as a reference number for payment, enquiry and amendment, if there is any which refers to that same LC. It carries important implications to the whole LC operations. There are cases where multiple LCs issued by the same issuing bank, at the request of the same buyer, addressed to the same seller, with the same amount and same currency. Therefore, the only way to identify which LC is to be paid, accepted or negotiated is by identifying the LC number.

Field 31C (Date of issue) on the other hand, signifies the date on which the LC is issued by the issuing bank. The undertaking to make payment by the issuing bank takes effect from this date. This field must contain 6 numeric characters only with no alphabet in the following manner, yy/mm/dd. For example, if the date is indicated as 070104, it is read as January 04th, 2007.

This date format is also applied to field 31D (Date and place of expiry) and field 44C (Latest date of shipment).

LC SWIFT Format: Field 40A (Form of Documentary Credit)

The second field in MT700/701 is field 40A. This is also a mandatory field where it must present and must be expressly stated to indicate the form of the Documentary Credit or LC. This field must contain one of the following codes:

IRREVOC TRANS STANDBY – The standby letter of credit is irrevocable and transferable

IRREVOCABLE – The documentary credit is irrevocable

IRREVOCABLE STANDBY – The standby documentary credit is irrevocable

IRREVOCABLE TRANSFERABLE – The documentary credit is irrevocable and transferable

REVOCABLE – The documentary credit is revocable

REVOCABLE STANDBY – The standby documentary credit is revocable

REVOCABLE TRANSFERABLE – The documentary credit is revocable and transferable

Article 3 of UCP600 stated that “…a credit is irrevocable even if there is no indication to that effect”.

This article says that, if none of the above codes are expressly indicated in field 40A of the SWIFT format, the LC is deemed irrevocable. Since field 40A is a mandatory field, it is a practice by banks worldwide to expressly indicate a code under this field. Article 3 of UCP600 is merely discouraging the practice of issuing a revocable LC to protect the interest of the seller. But this does not however, prohibits the practice of issuing a revocable LC. By virtue of article 1 which says, “…they are binding on all parties thereto unless expressly modified or excluded by the credit”.

This article allows both parties to modify or exclude some or part of the articles where a revocable LC may be an option.

28 December 2007

LC SWIFT Format: Field 27 (Sequence of Total)

As I mentioned in the previous post, LC is a message containing ‘to do list’, information, instruction which forms what is called terms and conditions. As LC is practiced worldwide, the terms and conditions expressly indicated must be arranged in a systematic order so as not to raise any misunderstanding and confusion. Therefore, they are arranged in a sequence order applied worldwide in a format developed by Society for Worldwide Interbank Financial Telecommunication or in short, SWIFT. LC messages travel from bank to bank electronically and finally delivered to seller in hard copy. There are various SWIFT Message Types (MT) used for a different purposes:

Category 0 – Financial System Messages
Category 1 – Customer payments & Cheques
Category 2 – Financial Institution Transfers
Category 3 – Treasury
Category 4 – Collection & Cash Letters
Category 5 – Securities
Category 6 – Treasury Markets
Category 7 – Documentary Credits & Guarantees
Category 8 – Travellers Cheque
Category 9 – Cash Management & Customer Status

LC is issued using MT category 7, which is specifically known as MT700/701 comprising an assigned sequence ‘fields’.

The first field of MT700/701 is field 27 (sequence of total). This field requires only number or figure to be indicated without alphabet and this field is a mandatory field. In other words, it must present and must be indicated. This field represents number of message and total number of messages.

For example, if 1/1 is indicated, it means that this is the only message in one page. 1/2 indicates that this is the first message of a total of 2 messages. In this case, the receiving bank must ensure that it receives both of the messages marking 1/2 and 2/2 under field 27. This is very important because LC carries monetary value and failure to receive all messages would caused unnecessary problem. In some instances, the message can be more than 3 pages.

26 December 2007

Part Four: Sample of LC issued (SWIFT Format)

27 : Sequence of Total
1 / 1

40A : Form of Documentary Credit

20 : Documentary Credit Number

31C : Date of Issue

40E : Applicable Rules

31D : Date and Place of Expiry

50 : Applicant

59 : Beneficiary

32B : Currency Code; Amount
GBP 20,151-23

41D : Available With...By...

42C : Draft At...

42D : Drawee

43P : Partial Shipment

43T : Transshipment

44E : Port of Loading / Airport of Departure

44F : Port of Discharge / Airport of Destination

44C : Latest Date of Shipment

45A : Descr of Goods / Services

46A : Documents Required

47A : Additional Conditions

71B : Charges

48 : Period of Presentation

49 : Confirmation Instruction

78 : Instruction to Pay / accpt / nego Bank

I will explain details of each terms and conditions in the next post.

24 December 2007

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.

23 December 2007

Part two: Letter of Credit defined

What is letter of credit? To understand what letter of credit is, we should first know the standard international rules that governed the operation of letter of credit which is known as Uniform Customs and Practice for Documentary Credits or in short, UCP.

The current UCP is known as Uniform Customs and Practice for Documentary Credits, 2007 Revision, ICC Publication no 600 or in short, UCP600. This is the sixth revision of the rules since they were first circulated in 1933. The primary objective of UCP is to alleviate the confusion caused by individual countries’ promoting their own national rules on letter of credit practice. UCP was established to create a set of contractual rules that would establish uniformity so that practitioners would not face national regulations conflict.

Under the current UCP600, letter of credit is defined in article 2 which reads as follow:

“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…”

In international trade community, letter of credit is known as ‘credit’ or popularly known as ‘LC’. There are few important criteria need to be highlighted from the definition above because they form the basic principle of letter of credit.

Irrevocable – In letter of credit transaction, they are three important parties involved namely, bank, buyer and seller. The letter of credit is issued by a bank which is known as ‘the issuing bank’ which acts on the instruction or at the request of the buyer. The buyer is the party who provides the instruction to the bank via a standard format form. Based upon the instruction or application form received from the buyer, the issuing bank issues the letter of credit to the seller.

Irrevocable here means, in any event, should any of the parties; buyer, seller or bank wishes to cancel the LC that has been issued by the issuing bank, a mutual agreement or consent in writing must first be obtained from the rest of the parties involved in the transaction. In the absent of such agreement or consent in writing, the LC cannot be cancelled or revoked and it stands as an operative instrument.

The LC, once issued, is said to be a definite undertaking of the issuing bank where it encapsulates the ‘guarantee’ or ‘promise’ of the issuing bank to the buyer that payment will be made to the seller. This ‘guarantee’ or ‘promise’ to make payment to the seller by the issuing bank is based on the presentation of the documents (invoice, packing list, Bill of Lading/Air waybill etc) within the stipulated time period as expressly stated in the LC by the seller. Failure to comply with the requirements (terms & conditions) of the LC, the seller would not entitled to the ‘guarantee’ or ‘promise’ of the issuing bank or in other words, he would not get his payment.

This is the first important basic principle on which the LC operates.

22 December 2007

Understanding Letter of Credit for beginners (Part One)

In trade transaction, there are two main objectives to be achieved; consideration for payment and consideration for the goods. Buyer wants to be assured that he received his goods and on the other hand, the seller would like to ensure that he would receive the value for his goods.

Let say, Sharif is a small trader in Malaysia operating his business in a shop lot in Kuala Lumpur selling canned food. He wants to buy a large quantity, one full container load (FCL) of canned sardine from Abdul, who is a food manufacturer residing in Singapore.

Shariff informs Abdul that he will list down important details like quantity of the canned sardine, brands, the place to deliver, time to deliver, amount and so on to show his intention to buy and to engage in this trade. The total value is, say, USD100,000.00. Abdul on the other hand, needs some time to prepare the delivery where he needs to process the sardine, to label the can, to pack and to contract for the transport before the goods can be delivered.

Now, there is one major problem. How can Abdul be sure that this list is coming from Shariff and Sharif would honour his word to pay him for USD100,000.00?

To ensure that this request is genuine and not a fake order, Abdul requires a third party, a bank, the organization recognized by law to give a confirmation or some kind of guarantee to ensure that Sharif would take the delivery of the goods on the agreed date and pay him the agreed amount. Without this confirmation or a guarantee by a bank, Abdul would refuse to prepare the goods for deliver.

So, Sharif goes to his bank, Maybank, and discusses this matter with his bank. His bank agrees to provide confirmation as well as a guarantee to Abdul provided that Shariff deposits USD100,000.00 equivalent sums with Maybank. Sharif agrees and hands over the list he made to Maybank and requests Maybank to issue the same instruction to Abdul in Singapore.

Maybank prepares the list based on the list which Sharif made with the inclusion of a few additional instructions where among others, Abdul is required to produce documentary evident for the delivery and how to obtain his payment. This list is sent through Abdul’s Bank in Singapore, DBS Bank. Upon receipt of the same, DBS Bank notifies Abdul and hands over the said list to him incorporating a guarantee for payment from Maybank.

Having received this list from Maybank in Malaysia, Abdul is assured that he will receive his payment from Maybank, not from Sharif provided that documentary evident must be sent to Maybank as evident that the delivery has been made on the agreed date to Sharif.

Upon making of the delivery, he sends the required documents to DBS Bank where they will be sent to Maybank for examination and when all the documents are presented as required, Maybank will debit Sharif’s account for USD100,000.00 and pay to Abdul through DBS Bank in Singapore.

Upon remittance of the money, Maybank will deliver the said documents to Sharif to enable him to collect the goods and pay the necessary duties and taxes.

The list issued by Maybank to Abdul through DBS Bank is called Letter of Credit. It contains the details like issuing date, expiry date, name of the buyer, name of the seller, address of both buyer and seller, type of goods, amount, documents required, shipment date, place of delivery and other important details related to this particular trade. All these details which are expressly stated are called ‘terms and conditions’.

In layman term, a Letter of Credit is a piece of list or letter incorporating terms and conditions for the seller to fulfill in order for him to obtain payment for goods he sold to the buyer.

21 December 2007

Reasonableness of 'reasonable time'

Prior to the revision of article 13, UCP 500, the period within which the documents should be check for conformity by banks is set at maximum of 7 banking days. Banks, must exercise ‘reasonable care’ and take ‘reasonable time’ not to exceed the time limit given and provided for in the article.

Effective July 2007, article 13 of UCP 500 is revised (article 14, UCP 600) with a slight different wording where the words ‘reasonable care’ and ‘reasonable time’ are deleted.

The word ‘reasonable time’ has caused many disputes among traders as to what is ‘reasonable time’. How does it determined and who is to determine the number of days so called ‘reasonable’. But of course, this ‘reasonable time’ must not exceed 7 banking days. The maximum number of days, which is 7 banking days is not much of an issue of dispute. The centre of dispute is, is it deemed ‘reasonable’ for banks to consume 2 days, 3 days, 4 days or more within that given maximum period to decide whether or not the documents are compliance. The same applies if bank refuses to take up the documents.

The question now is, is the article 14(b), UCP 600 totally eliminates the same disputes triggered by article 13 of UCP 500? This change, the deletion of the words reduces the disputes among traders. But there is another problem arises which come to almost the same issue caused by article 13 of UCP 500.

The dispute on ‘reasonableness’ again surfaces by virtue of article 1 of UCP 600. The article states that:

“…they are binding on all parties thereto unless expressly modified or excluded by the credit”.

This article causes another debate, what if a bank decides on the second day that the documents are compliant. Can the seller insist on payment on that second day or must he waits until the fifth day for payment?

Can the seller request to modify the clause by inserting words, for example, “…providing for payment within 3 banking days of presentation of the following documents…” in the credit? Is it deemed reasonable to demand payment say, on the second day, third day or forth day?

The survey of court decision on ‘reasonable time’ suggests that depending upon the circumstances, a court’s interpretation of a reasonable time could be firstly, the day of receipt of the documents by the bank, if that were the day when the bank made, or should have made, the decision to reject and dishonour or secondly, a period of time ranged from three days in some decisions, to more than three years in another decisions, regardless of when the decision to accept or to reject the document was made by the bank

Among other criteria on which reasonableness depends are the circumstances of presentation, the type and the value of documents. At one end of the spectrum one may encounter an examination of hundreds of documents. This examination could consume every hour of the five-day period. At the other end, a simple statement of indebtedness of principal or interest concerning a financial Standby Credit may consume no more than a few hours of the examination period.

Premised on the above, banks have the advantage to determine what is the ‘reasonable time’ based upon the circumstances of their operations. If it is customary for that particular bank to process on average, say, 50 documents per day and takes 3 days to decide whether to honour or to refuse, therefore 3 days is deemed “reasonable”. Other banks may take up lesser time or more time to complete checking and to decide. Whatever the case may be, banks should not exceed the time limit given that is 5 days, maximum.

16 December 2007

Collections: Documents Against Payment

“Please advise what is the difference between L/C and D/P payment ? Thanks in advance”.

A question received from Helen Jolee, China.

LC, as we all know, is a written undertaking by the issuing bank to guarantee that the payment will be honoured upon presentation of documents and in compliance with the terms and conditions of the LC.

DP or Documents Against Payment or Collections does not constitute an undertaking to make payment by presenting bank or accepting bank. The movement of the documents from the seller to the buyer under DP is quite similar to those documents drawn under the LC. The seller will prepare all the necessary documents and present them to his bank for onward redirection to the buyer’s bank. The seller’s bank or the collecting bank, upon receipt of the documents, is not obligated to examine the said documents to establish compliance.
Unlike LC, Collections is governed by separate standard international rules called Uniform Rules for Collections (URC 522). Under these rules, collecting bank is merely acting as an ‘agent’ for the seller where its’ responsibility is only restricted to ‘handling’ the documents and ‘collecting’ proceeds. In doing so, collecting bank must take necessary steps to provide full information pertaining to the documents it receives to the paying bank. This includes, type of documents, number of pieces of each document, how payment should be transmitted, amount, currency and so on. The documents than are couriered the paying bank for presentation to the buyer.

The paying bank will notify the buyer and make presentation by obtaining payment for the documents value, that is switching documents for payment. The paying bank is also merely acting as and ‘agent’ to collect payment from the buyer and deliver the documents. If the buyer fails to pay on first presentation, the paying bank has no authority to demand neither can it enforce any legal mechanism to obtain payment from the buyer.

The ‘ownership’ of the documents under Collections is held by the seller. The seller is the party in this operations who makes a call. The paying bank only acts according to the instruction of the seller via instructions provided for by his bank (Collecting bank).

This method of trade settlement is much riskier as compare to LC. However, it is also widely used in international trade especially involving parties of the same group of companies. First time traders are not advised to resort to this method as the probability of non payment is very high.

15 December 2007

Presentation of documents

A freely negotiable LC with the expiry date on the 01st of December, 2007. Beneficiary presents the documents to his bank in his country on 30th of November 2007. The documents are not negotiated but instead redirected to the issuing Bank by courier service and reached the issuing Bank on the 05th of December, 2007.

Is the LC deemed to be expired? Is it a discrepancy?

One participant from India suggested that it is a discrepancy because the LC reached the Issuing Bank after the 01st of December, 2007.

Article 2 of UCP600 states that “presentation means either the delivery of documents under a credit to the issuing bank or nominated bank or the documents so delivered”.

In layman term, the beneficiary has the option, either to send the documents to his bank or to the issuing bank if the issuing bank is also in his country. In the case where trading parties domicile within the same country or within the same vicinity, the beneficiary may send the documents directly to the issuing bank. For example, the LC is issued by Maybank, in Kuala Lumpur that is the buyer’s bank and the seller is also in Kuala Lumpur where he maintains an account with Stanchart which also in Kuala Lumpur. The beneficiary may either send the documents directly to the issuing bank, that is Maybank or he may also send the said documents to his bank that is Stanchart. When the documents reached the counter either one of these banks, he is said to have made a ‘presentation’ and therefore, he owes no further obligation as far as presentation is concerned.
Article 6(d)(i) of UCP 600 clearly states that "...an expiry date stated for honour or negotiation will be deemed to be an expiry date for presentation..." Article 6(d)(ii) further states "...the place for presentation under a credit available with any bank is that of any bank..."
From this point onwards, responsibility shifts to the nominated bank to examine the documents to determine whether or not the documents comply with other terms and conditions of the LC. It may take 1 day, 2 days or more but not to exceed 5 banking days.

To escape refusal by bank, the beneficiary must also ensure that the documents reach the bank within the validity of the presentation period which is within the expiry date of the LC.

Upon receipt of the said documents from the nominated bank, the issuing bank must first establish the date on which the presentation was made at the nominated bank. This is only a matter of checking the date on the covering schedule provided for by the nominated bank. The date indicated on the covering schedule is deemed to be the date on which the presentation is made at the nominated bank. This is the routine process in checking the documents by banks. If the indicated date is before the expiry of the LC, it is not a discrepancy.

More information, click the following links:

13 December 2007

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.

12 December 2007

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.

11 December 2007

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.

10 December 2007

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.

08 December 2007

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.

06 December 2007

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.

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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