A Complete Guide To Letters Of Credit And The Ucp

Foreign trade, also referred to as international trade, is the exchange of money (capital), men (people) material (goods) and services between countries. Domestic trade, on the other hand, is confined within the international border of a country. Foreign trade is different from domestic trade in many respects. Foreign trade also has serious implications for the economy of a country.

One of the critical issues that the buyer and the seller must agree upon during negotiation is the manner of settlement of dues against the goods purchased. There is no ‘one size fits all’ formula that can be applied. The method of settlement that the seller/exporter and the buyer/ importer agrees between themselves depends on a combination of the following factors: (i) Track record and experience while dealing with the counterparty (ii) Level of mutual trust, confidence and comfort (iii) Creditworthiness and reliability of the counterparty (iv) Market conditions (v) External risk factors such as country risk (vi) Exigencies, urgency for the product or service (vii) Bargaining power to secure the most favourable terms (viii) Conditions imposed by a third party (viz. insurance agency, exchange control regulations) (ix) Insurance cover or guarantee by a third party (including a bank) against risk of nonpayment by principal (x) Import/export regulations. Instruments such as bank guarantees and letters of credit are useful instruments for the settlement of international trade. The foregoing shows that it is necessary to have a good understanding of the various options available for the settlement of trade, as also the risks and advantages associated with each. For convenience, the payment methods have been divided into two broad groups. The first group covers trade operations where shipping documents are not routed through commercial banks. The second group is all about instances where shipping documents are routed through banks. From the next chapter, the focus will be exclusively on the latter and everything related to it. In this chapter we introduce some of the more common payment options available. These are equally applicable to domestic, as well as, international trade. The risks associated with each of these methods of payment would be analysed and compared, simultaneously.

A ‘documentary letter of credit’, also referred to as ‘letter of credit’ or simply ‘LC’, is an irrevocable, written undertaking by a commercial bank, issued at the request of the buyer (applicant) in favour of the seller (beneficiary), to the effect that payment for certain goods or services will be made against a complying presentation of documents. Article 2 of UCP 600 defines a (letter of) credit as, ‘Any arrangement, however named or described, that is irrevocable and thereby constitutes a definite undertaking of the issuing bank to honour a complying presentation’. Note that an LC issued under UCP 600, by its very definition, is an irrevocable instrument from its very inception. If issued under UCP 600, this fact need not be (re)stated on the face of the credit.

Certain terms and expressions are an integral part of international trade and documentary credit operations. Some of the terms that are more frequently used are: (i) Presentation – of documents under a credit, for sight payment, deferred payment, acceptance or negotiation (ii) Availability – of a letter of credit to a beneficiary (iii) Nominated bank – for the purpose of availability and utilisation of a letter of credit (iv) Restriction – with regard to the availability of a credit (v) Engagement, obligation – of a bank while advising a credit (vi) Recourse and without recourse – payment modes under credits that are either confirmed, unconfirmed, advised with or without obligation (vii) Under reserve – payment to an exporter/seller upon purchase, discount or the negotiation of outward bills The other important terms would be explained at appropriate places later in the book. In this chapter we offer a brief explanation of each of the foregoing terms and discuss related issues.

The UCP does not, as such, offer standardised definitions for the types of credits as we would normally come across in textbooks. As will be evident in due course, the definitions and characteristics of certain types of credits have to be derived from the articles in the UCP or the purpose the credit is created to serve. For example, although UCP 600 contains a separate article (Article 2 titled Definition) introduced for the first time ever in any UCP, this article does not include a formal definition of any type of documentary credit – save and except one. The UCP being all about documentary letters of credit (or simply ‘credit’, as the UCP terms it nowadays) Article 2 does define a ‘credit’. It is defined as an arrangement that is irrevocable in nature. However, what makes a credit irrevocable, the features that characterises an ‘irrevocable’ credit, are available not under Article 2 (devoted to ‘definitions’) but elsewhere in the UCP. Similarly, Article 8 describes the liabilities and responsibilities of a confirming bank. A close study of this article reveals the special characteristics of a credit confirmed by another bank. Accordingly, we get to learn all about confirmed credits. By extension of this logic, we may define ‘unconfirmed’ credits as those which are not ‘confirmed’, and hence not covered by Article 8. Article 6(a) calls on the issuing bank to state with which bank a credit is made available. Article 6(b) states that, ‘a credit must state whether it is available by sight payment, deferred payment, acceptance or negotiation.’ Thus, the UCP provides a clue as to how a credit could be distinguished according to its availability. However, the UCP – being about rules rather than procedures – does not define ‘availability’ clearly. The very same credit, therefore, could be ‘available by negotiation’ with a nominated bank, while simultaneously being ‘available by sight payment’ (honour) with the issuing bank. Proceeding further, Article 32 deals with ‘instalment drawing or shipment’ and outlines the characteristics of a credit available by instalment. This article, therefore, helps us to categorise such credits as one of the types of credit that we should know about. Finally, Article 38 of UCP 600 devotes itself exclusively to transferable credits. Sub-article 38(b) also defines a transferable credit. Thus the UCP, through its various articles, helps us to define and profile certain types of credits. But the list does not end here. The types of credits extend beyond those described in the UCP.

This chapter deals exclusively with Transferable Credits, since it is different from other types of credits. UCP, too, devotes a separate article (Article 38) exclusively to Transferable Credits. A transferable credit may be defined as a credit, marked ‘transferable’ at the time of issue, that is, made available in whole or in part to another beneficiary (or multiple beneficiaries) if so requested by the first (the original) beneficiary, to the extent and in the manner expressly consented to by a bank that has been specifically nominated and authorised by the issuing bank to effect such transfer. Article 38 of UCP 600 deals exclusively with ‘transferable credits’.

Back-to-back credits play an important role in international trade, domestic trade and also in merchanting trade. For a credit to be defined as a Back-to-back Credit, there should at least be two letters of credit – the original (mostly for export, but could be for domestic trade, too), and the second credit that rides on the back of the original.

An overview of the various methods of payment, the risks inherent in these methods, and the types letters of credit commonly used in international trade, was provided in the preceding chapters. We now take up the operational aspects of letters of credit, and analyse the key issues relating to each stage in their life cycle – from the application for issue, right up to their utilisation or cancellation. This chapter deals with the first couple of stages in that life cycle.

The success of all documentary credit operations is dependent on appropriate documents being specified by the applicant, and presentation of complying documents by the beneficiary. The applicant’s every expectation or requirement must, therefore, be translated to, and stated in terms of documents – in such form and content that provide for scrutiny and verification by the intermediary banks to ensure compliance with credit terms.

A wide range of topics about documents related to international trade was discussed in the foregoing chapters. As had been explained earlier, our interest in documents is primarily for the following reasons: (a) To better understand the nature of the documents used in trade and commerce, especially international trade, and (b) To understand and internalise the rules related to documents and documentation in international trade, especially when viewed in the context of documentary credit operations. This chapter rounds up our deliberation on documents. Since collection bills do not call for too many rules, their strict implementation or compliance, our main focus is on the use of various documents under documentary credit operations.

The various stages from inception right up to the issue and advising of letters of credit were taken up in the preceding chapters. Along the way, rules on amendment of credit, the UCP rules on documentation, types of shipping documents and bills of exchange, types of credits, and some definitions and terms integral to the operations of documentary credits were discussed in detail. Each stage of the process was analysed and the critical issues relating to each were clarified. We now move to the next part of the documentary credit operation, which concerns the utilisation of documentary credits. The topics which we will be taking up next are as follows: (a) Presentation of documents (b) Negotiation, acceptance or payment (honour) under LC (c) Dealing with discrepancies in documents (d) Banks’ role in utilisation of documentary credit (e) The rules that apply to each of these stages, up to the point of realisation of export documents under LCs

A domestic or an international trade transaction begins with an initial contact, followed by an agreement or a contract of sale between the buyer and the seller. However, for various reasons, additional contracts are also required to satisfactorily conclude a transaction. Delivery is one of the key performance parameters. For this, the goods would have to be moved from the seller’s place to the place selected by the buyer. It would be necessary to arrange and pay for transport. Complications arise as three parties are now involved, the seller, the buyer and the carrier. The trade terms, a link between sellers and buyers, try to answer a number of questions that are of concern to the buyer and the seller. Who shall arrange and pay for the carriage of the goods from one point to another? Who shall arrange and pay for export and import licences? Who shall bear the risk of loss or damage in transit or if the operations cannot be carried out? Essentially, at what exact point do the sellers’ risks end and the buyers’ begin? For the sake of expediency, the merchant community had developed short expressions to convey messages from one party to another by reference to a pre-established set of terms. These expressions were usually integrated into their contracts. Over the years most of the frequentlyused terms were referred to by three-letter abbreviations. For obvious reasons the seller would want to escape the risk of loss of or damage to the goods while in transit, up to and including the point where the seller undertakes to deliver the goods at destination to the buyer. The fact that the seller may be protected by insurance in case of loss of or damage to the goods in transit would not relieve him from his obligation under the contract of sale to deliver the goods to the buyer. The sales contract had to be expanded in scope to accommodate such contingencies and fix liabilities. The terms of shipment had to clearly reflect the mutual arrangement in as much detail as possible. This is where the ICC stepped in, and introduced what we know as the Incoterms rules. Created by the International Chamber of Commerce (ICC), the Incoterms rules now are a series of internationally recognised standardised trade terms widely used in international sales. It shortens a contract, standardises the terms of shipment, but does not replace a complete contract of sale. These matters are normally dealt with through express terms in the contract of sale or in the law governing that contract.

Marine insurance covers the loss or damage of ships, cargo, terminals, and any transport or cargo by which property is transferred, acquired, or held between the points of origin and final destination. Cargo insurance is a branch of marine insurance, though Marine also includes onshore and offshore exposed property (container terminals, ports, oil platforms, pipelines), hull, marine casualty, and marine liability. The growth of the London insurance market led to the standardization of marine insurance policies. Judicial precedent further developed marine insurance law. In 1906 the Marine Insurance Act was passed in the UK which codified the previous common law. It is both an extremely thorough and concise piece of work. It has withstood the test of market practice and judicial review over the years. Although the title of the Act refers to ‘marine insurance’, the general principles have been applied to all non-life insurance, with appropriate variations.