Reasons Why Letters of Credit Fail

1) Not Adhering to Time Lines

The LC should have an expiration date that gives sufficient time to the seller to get all the tasks specified and the documents required in the LC. If the LC expires, the seller is left with no protection. Most LC s fail because Sellers/Exporters/Beneficiaries were unable to perform within the specified time frame in the LC.

Three dates are of importance in an LC:
a) The date by when shipment should have occurred. The date on the Bill of Lading.
b) The date by when documents have to be presented to the Bank
c) The expiry date of the LC itself.

A good source to give you an idea of the timelines would be your freight forwarding agent. As a seller check with your freight forwarding agent to see if you would be in a position to comply.

2) Not Noticing The Built-In Discrepancy In the Letter of Credit

Letters of credit could also have discrepancies. Even a discrepancy as small as a missing period or comma can render the document invalid. Thus, the earlier in the process the letter of credit is examined, the more time is available to identify and fix the problem. This is another common reason why LCs fail.

3) Compliance with the Documents and Conditions within the Letter of Credit.

Letters of Credit are about documents and not facts; the inability to produce a given document at the right time will nullify the letter of credit. As a Seller/Exporter/Beneficiary you should try and run the compliance issues with the various department or individuals involved within your organization to see if compliance would be a problem. And if so, have the LC amended before shipping the goods.

Learning the Terminology of Exporting INCOTERMS

Shipping terms set the parameters for international shipments, specify points of origin and destination, outline conditions under which title is transferred from seller to buyer, and determine which party is responsible for shipping costs. They also indicate which party assumes the cost if merchandise is lost or damaged during transit. To provide a common terminology for international shipping, INCOTERMS (International Commercial Terms) have been developed under the auspices of the International Chamber of Commerce.

Want to know about the latest Incoterms? You can read it here.

How Courts View the Cases Relating To Letter of Credit

The courts in most countries do not like litigation around LCs -especially the hair splitting over the provisions of UCP. The principles followed by the US courts are given in the Article 5 of the Uniform Commercial Code (UCC) governs L/Cs.

Article 5 is founded on two principles: (1) the LC's are independent from the underlying business transaction, and (2) strict compliance with documentary requirements. Any other deviation is strictly frowned upon. This is the standard followed by most countries across the world.

1) Strict Compliance

How strict compliance? Some courts insist upon literal compliance, so that a misspelled name or typographical error voids the exporter's/beneficiary's/seller's demand for payment. Other courts require payment upon substantial compliance with documentary requirements. The bank may insist upon strict compliance with the requirements of the L/C. In the absence of conformity with the L/C, the Seller cannot force payment and the bank pays at its own risk. Sellers should be careful and remember that the bank may insist upon strict compliance with all documentary requirements in the LC. If the documents do not conform, the bank should give the seller prompt, detailed notice, specifying all discrepancies and shortfalls.

2) The Independence Doctrine

Letters of credit deal in documents, not goods. L/Cs are purely documentary transactions, separate and independent from the underlying contract between the Buyer and the Seller. The bank honoring the L/C is concerned only to see that the documents conform with the requirements in the L/C. If the documents conform, the bank will pay, and obtain reimbursement from the Buyer/Applicant. The bank need not look past the documents to examine the underlying sale of merchandise or the product itself.

The letter of credit is independent from the underlying transaction and, except in rare cases of fraud or forgery, the issuing bank must honor conforming documents. Thus, Sellers are given protections that the issuing bank must honor its demand for payment (which complies with the terms of the L/C) regardless of whether the goods conform with the underlying sale contract.

The Stages of the Letter of Credit

The Stages of the Letter of Credit

1. Buyer and seller agree terms, including means of transport, period of credit offered (if any), latest date of shipment, Incoterm to be used

2. Buyer applies to bank for issue of letter of credit. Bank will evaluate buyer's credit standing, and may require cash cover and/or reduction of other lending limits

3. Issuing bank issues L/C, sending it to the Advising bank by airmail or (more commonly) electronic means such as telex or SWIFT

4. Advising bank establishes authenticity of the letter of credit using signature books or test codes, then informs seller (beneficiary). Advising bank MAY confirm L/C, i.e. add its own payment undertaking

5. Seller should now check that L/C matches commercial agreement, and that all its terms and conditions can be satisfied, (e.g. all documents can be obtained in good time.) If there is anything that may cause a problem, an AMENDMENT must be requested.

6. Seller ships the goods, then assembles the documents called for the L/C (invoice, transport document etc.) Before presenting the documents to the bank, the seller should check them for discrepancies with the L/C, and correct the documents where necessary.

7. The documents are presented to a bank, often the Advising bank. The Advising bank checks the documents against the L/C. If the documents are compliant, the bank pays the seller and forwards the documents to the Issuing bank

8. The Issuing bank now checks the documents itself. If they are in order (and it is a sight L/C), it reimburses the seller's bank immediately

9. The Issuing bank debits the buyer and releases the documents (including transport document), so that the buyer can claim the goods from the carrier.

What is a Letter of Credit?

A letter of credit is a banking mechanism which allows importers to offer secure terms to exporters.

All letters of credit contain these elements:

* a payment undertaking given by the bank (issuing bank)
* on behalf of the buyer (applicant)
* to pay a seller (beneficiary)
* a given amount of money
* on presentation of specified documents representing the supply of goods
* within specific time limits
* these documents conforming to terms and conditions set out in the letter of credit
* documents to be presented at a specified place.

Put simply, the issuing bank's role is twofold:

* to guarantee to the seller that if compliant documents are presented, the bank will pay the seller the amount due. This offers security to the seller - the bank says in effect "We will pay you if you present documents (XYZ)"

* to examine the documents, and only pay if these comply with the terms and conditions set out in the letter of credit. This protects the buyer's interests - the bank says "We will only pay your supplier on your behalf if they present documents (XYZ) that you have asked for"

Company Formations - Start Your Own Company

Note that the letter of credit refers to documents representing the goods - not the goods themselves! Banks are not in the business of examining goods on behalf of their customers
Typically the documents requested will include a commercial invoice, a transport document such as a bill of lading or airway bill, an insurance document; but there are many others.

Letters of credit deal in documents, not goods.

What are the stages of the Letter of Credit? We shall see this in our next post..