Unit 4. Documentary Letters of Credit

Unit 4. Documentary Letters of Credit

  1. In international trade, where buyers and sellers are far apart in two different countries, or even continents, the Letter of Credit acts as a most convenient instrument, giving assurance to the sellers of goods for payment and to the buyers for shipping documents, as called for under the Credit.
  2. In order to bring an uniformity in matters pertains to LC Documents and Transactions, International Chamber of Commerce formed rules and procedures. Those are called as

Uniform Customs and Practices for Documentary Credits (UCPDC).

  1. The International Chamber of Commerce (ICC)was established in 1919 headquartered at Paris.
  2. The first UCPDC published in 1933 and has been revised from time to time in 1951,

1962,1974,1983,1993 and recently in 2007.

  1. The updated UCPDC in 2007 is called as UCPDC 600. And it has been implemented w.e.f 1-7-2007.
  2. Documentary Credit/Letter of Credit: LC/DC cane be defined as a signed or an authenticated instrument issued by the buyer’s Banker, embodying an undertaking to pay to the seller a certain amount of money, upon presentation of documents, evidencing shipment of goods, as specified, and compliance of other terms and conditions..
  3. IN an LC Parties are as follows:
  4. The buyers/Importers or the applicant – on whose behalf LC is opened.
  5. The Sellers/Exporters or the Beneficary of the LC
  6. The opening Bank (Buyer’s Bank), who establishes the LC
  7. The advising bank (Bank in sellers country), who acts as an agent of the issuing bank and authenticates the LC.
  8. The confirming Bank- Who undertakes to pay on behalf of the issuing bank.
  9. The negotiating Bank ( Seller’s bank or Bank nominated by the opening Bank)
  10. Reimbursing Bank – Who reimburses the negotiating or confirming bank.

For example, in a hypothetical Situation given below:

Mr Ram, (Banking with Dhanlaxmi Bank) an agriculture entrepreneur growing vegetables in green house technology in Khammam wants to update his farm house with modern  machinery. He is importing the same from a Chinese manufacturer M/s Zuanch LLC, Beijing who are banking with China Development Bank for total cost of US$ 4500. M/s Zaunch LLC has issued an invoice stating the sale transaction must be backed by LC. As such, Mr Ram approaches Dhanlaxmi Bank for opening of Letter of Credit (Foreign) in FCY USD. Dhanlaxmi Bank’s China Foreign Correspondent Bank is Bank of China, Beijing.

Applicant of LC - Mr Ram, Khammam

Beneficiary of LC - M/s Zaunch LLC

LC Opening/ Issuing Bank - Dhanlaxmi Bank

Advising Bank /Confirming Bank - Bank of China

Negotiating bank China - Development Bank

Reimbursing Bank - Bank of China in China

  1. 8. Types of Letters of Credit
  2. Revocable LC
  3. Irrevocable LC
  4. Irrevocable Confirmed LC
  5. Transferable LC
  6. Red Clause LC
  7. Sight/Acceptance, Deferred Payment, or Negotiation LC
  8. Back to Back LC
  9. Revocable LC can be amended or cancelled at any moment by the issuing bank without the consent of any other party, as long as the LC has not been drawn or documents taken up.
  10. In case the Negotiating Bank has taken up the documents under revocable LC, prior to receipt of cancellation notice, the issuing bank is liable to compensate/reimburse the same to the negotiating bank.
  11. Irrevocable LC which holds a commitment by the issuing bank to pay or reimburse the negotiating bank, provided conditions of the LC are complied with.
  12. Irrevocable LC cannot be amended or cancelled without the consent of all parties concerned.
  13. The irrevocable LC is an unconditional undertaking by the issuing bank to make payment on submission of documents conforming to the terms and conditions of the LC
  14. All LCs issued, unless and otherwise specified, are irrevocable Letter of Credits.
  15. Irrevocable confirmed LC is an L/c which has been confirmed by a bank, other than the issuing a bank, usually situated in the country of the exporter, thereby taking an additional undertaking to pay on receipt of documents conforming to the terms & conditions of the LC
  16. The Conforming Bank can be advising Bank, which on receipt of request from the issuing banktakes this additional responsibility.
  17. The conforming bank steps into the shoes of the issuing bank and performs all functions of the issuing bank.
  18. Transferrable LC is available for transfer in full or in part, in favour of any party other than beneficiary, by the advising bank at the request of the issuing bank.
  19. Red Clause LC enables the beneficiary to avail pre-shipment credit from the nominated/advising bank. The LC bears a clause in “RED Letter” authorizing the nominated bank to grant advance to the beneficiary, prior to shipment of goods, payment of which is guaranteed by the Opening Bank, in case of any default or failure of the beneficiary to submit shipment documents.
  20. Under a Sight LC, the beneficiary is able to get the payment on presentation of documents conforming to the terms and conditions of the LC at the nominated bank’s countries.
  21. Under the Acceptance Credit, the bill of exchange or drafts are drawn with certain Usance period and are payable upon acceptance, at a future date, subject to receipt of documents conforming to the terms and condition of the LC.
  22. A Deferred Payment Credit is similar to Acceptance Credit, except that there is no bill of exchange or draft drawn and is payable on certain future date, subject to submission of credit confirmed documents. The due date is generally mentioned in the LC
  23. A Negotiation Credit, the issuing Bank undertakes to make payment to the Bank, which has negotiated the documents.
  24. In a Negotiation LC, LC may be freely negotiable or may be restricted to any bank nominated by the LC issuing Bank.
  25. Back to Back LC: when an exporter arranges to issue an LC in favour of Local supplier to procure goods on the strength of export LC received in his favour, it is known as Back to Back LC.
  26. UCP 600 come into force w.e.f. 01/07/2007.
  27. Important Changes in the Articles of UCP 600 and their implication for the Banks:-

# A reduction in the number of articles from 49 to 39

# New articles on "Definitions" and "Interpretations" providing more clarity and precision in the rules

# A definitive description of negotiation as "purchase" of drafts of documents

# The replacement of the phrase "reasonable time" for acceptance or refusal of documents by a maximum period of five banking days

# New provisions allow for the discounting of deferred payment credits

# Banks can now accept an insurance document that contains reference to any exclusion clause

  1. UCP 600 does not apply by default to letters of credit issued after July 1st 2007. A statement needs to be incorporated into the credit (LC), and preferably also into the sales contract that expressly states it is subject to these rules.
  2. Revocable Credits (Article 2): One of the most important changes in UCP 600 is the exclusion of any verbiage regarding revocable letters of credit, which can be amended or canceled at any time without notice to the seller. .Actually, Article 2 explicitly defines a 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."
  3. Article 3 states that "A credit is irrevocable even if there is no indication to that effect." And Article 10 makes it clear that "a credit can neither be amended nor cancelled without the agreement of the issuing bank, the confirming bank, if any, and the beneficiary" (seller).Therefore, it is prudent for the seller to stipulate in the sales contract that the "buyer will open an irrevocable letter of credit", and to check that the buyer's credit does, in fact, either describe itself as "irrevocable" or state that it incorporates UCP 600 (without exclusion).
  4. Definitions and Interpretations (Articles 2 and 3): A new section of Definitions and Interpretations has been introduced in the UCP 600. This includes definitions of "Advising bank", "Applicant", "Banking day", "Beneficiary", "Complying presentation", "Confirmation", "Confirming bank", "Credit", "Honour", "Issuing bank", "Negotiation", "Nominated bank", "Presentation","Presenter". In addition to that, the following terms are now clearly defined : "singular/plural","irrevocable", "signatures", "legalizations", "Branches of a bank", "Terms describing issuer of a document", "Prompt etc", "on or about", "to", "until", "till", "from", "between", "before", "from", "after", "first half", "second half", "beginning", "middle", "end".
  5. Deferred payment undertakings - Articles 7 and 8 :. Articles 7 and 8 establish a definite undertaking by issuing and confirming banks to reimburse on maturity whether or not the nominated bank prepaid or purchased its own acceptance or deferred payment undertaking before maturity.
  6. Article 12(b) expressly provides authority from an issuing bank to a nominated bank to discount prepay or purchase) a draft that it has accepted or a deferred payment undertaking that it has given.
  7. Advising of credits - Article 9: At present an advising bank only has to verify the apparent authenticity of the credit that it has advised. Under art 9(b) it has to certify that the document that it advises to the beneficiary is the same document that it received. The obligation is also extended to any second advising bank.
  8. Amendments - Article 10:- The position under article 9(d)(iii) of UCP 500 has been maintained in Article 10 under UCP 600. Article 10 now deals exclusively with amendments and article 10(c) provides: '… The beneficiary should give notification of acceptance or rejection of an amendment. If the beneficiary fails to give such notification, a presentation that complies with the credit and to any not yet accepted amendment will be deemed to be notification of acceptance by the beneficiary of

such amendment.

  1. Time Allowed Banks for Document Review (Article 14) :-

- Under UCP 500, banks have a "reasonable time … not to exceed seven banking days" in which to honor or dishonor documents.

- UCP 600 shortens the period to a maximum of five "banking days".

  1. Article 2 defines a banking day as "a day on which a bank is regularly open at the place at which an act subject to these rules is to be performed."
  2. Non-Matching Documents (Article 14):- Article 14(d) provides the standard for examination of documents generally. It seeks to resolve the problem of inconsistency in data by clarifying that there is no need for a mirror image but rather
  3. Regarding addresses on the various documents, Article 14 indicates that they do not have to exactly match as long as the country is the same. The only exception is when addresses appear as part of the consignee or notify party details on a transport document, in which case they must be the same as stated in the credit.
  4. Examination of documents: The standard for examining documents is reflected in article 14.

Banks now only have 5 banking days to accept or refuse documents. This replaces the "Reasonable time not exceeding 7 banking days".

  1. The period for presentation (usually 21 days) only applies to original transport documents.
  2. Addresses of beneficiaries and applicants need no longer be as mentioned in the documentary credit. They must however be within the same country.
  3. Non-Documentary Requirements: - Under UCP 600, Banks should disregard all non-documentary requirements. This means that any requirement in the credit that is not specifically part of a required document will be ignored by the bank in determining conformity.
  4. Complying presentation - article 15:- Under UCP 600 it is clear that this begins when the bank determines that a presentation is compliant.
  5. Discrepant documents, waiver and notice - Article 16:- Under UCP 500 a bank which refuses documents has the option of holding them at the presenter's disposal or handling them in accordance with the presenter's prior instructions, such as to return them. Article 16 now encompasses additional options designed to avoid banks sitting on discrepant documents and issues relating to forced waivers.

The options (which are alternatives) are as follows:

# Hold documents pending further instructions from the presenter; or

# Hold documents until it receives a waiver from the applicant and agrees to accept it, or receives further instructions from the presenter prior to agreeing to accept a waiver; or return the documents; or act in accordance with instructions previously received from the presenter. There is no provision for payment under reserve or indemnity.

  1. Original Documents (Article 17):- Article 17 of the new rules attempts to define original documents with more precision.
  2. Transport documents: Articles 19-24:- The transport articles have been redrafted under advice of a group of "transport experts". The requirement that a bill of lading must show that goods are shipped on board a named vessel has been made much simpler which will hopefully lead to less confusion.
  3. It is now acceptable that a "Charterer" (or a named agent on behalf of the charterer) can sign a Charter Party Bill of Lading. If an agent signs on behalf of a "Master" on a Charter Party Bill of Lading then the name of the master need not appear from the document.
  4. Under UCP 600 a generic set of rules generally applies to all transport documents (other than charter party bills of lading). These include the following:

# The document must indicate the name of the carrier and be signed by: (a) the carrier or named agent for or on behalf of the carrier; or (b) the master or named agent for or on behalf of the master.

# Any signature by the carrier, master or agent must be identified as that of the carrier, master or agent.

# Any signature of an agent must indicate whether the agent has signed for or on behalf of the carrier for or on behalf of the master.

# There is no need to name the master.

# In the case of charter party bills of lading :

# These no longer need to indicate the name of the carrier.

# They may now also be signed by the charterer, although it is difficult to envisage a situation where an FOB buyer/ applicant would wish to rely on a bill of lading signed by the seller/beneficiary and vice versa in the case of a CIF sale.

# Transport documents also no longer need to bear the clause 'clean' in order to comply with any credits that require a document to be 'clean on board'.

  1. Insurance documents - article 28:- Documents providing for wider coverage than stipulated in a credit will be acceptable. Banks will also be able to accept an insurance document that contains reference to any exclusion clause.
  2. For the insurance documents the following has been changed: "Proxies" can now sign on behalf of the insurance company or underwriter.
  3. Force majeure - Article 36:-Despite suggestions for an option to allow a grace period of five banking days after a bank reopens for the presentation of documents, the position remains as it was under UCP 500 -i.e. banks will not honour or negotiate under a credit that expired during the force majeure event.
  4. It is the responsibility of the Negotiating bank to examine the documents, before making payment.
  5. In case the advising bank does not advise the LC, it must inform of its decision to the Opening Bank immediately.
  6. The advising bank must ensure the authenticity of LC before advising the same to the beneficiary.
  7. In case the reimbursing bank does not pay to the negotiating bank, the ultimate liability lies with the opening bank.
  8. Important documents called for under the Letter of Credit :
  9. Bill of Exchange
  10. Invoice
  11. Bill of Lading
  12. Insurance Policy/Certificate
  13. Certificate of Origin
  14. Packing List, Weight List and other Documents
  15. Bill of exchange is drawn by the Beneficiary on the LC issuing Bank.21
  16. Invoice is a commercial Document and is a basic necessity of trade documents. It is being prepared by the Beneficiary
  17. If invoice is issued for an amount in excess of the amount permitted by credit (when not

specifically prohibited by the terms of LC), as per Article 18 B of UCPDC, the drawing should not exceed the amount of credit.

61. Bill of Lading is a transport document evidencing movement of goods from the port of acceptance to port of destination. It is a receipt issued by the ship owner or its authorized agent.

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