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SITPRO Simplifying International Trade

Download PDF EditionLetters of Credit - Best Practice
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This guide details the best practice for the operation of letters of credit (L/C) -also referred to by banks and other financial institutions as documentary credits. Topics covered in the guide include: negotiation; checking the letters of credit on receipt; documentation requirements; and, in the event of a worse case situation, what to do if a letter of credit is rejected by the bank on first presentation.

You should read this guide together with the guide Letters Of Credit - An Introduction and SITPRO's set of three Letters of Credit Checklists and Guides for Importers, Exporters and Export Sales Representatives. The checklist designed for importers is to be used by purchasing staff when applying to local banks for letters of credit. The one for exporters is intended primarily for use in export sales and shipping departments. The export sales representative's guide advises on credits and some of the other responsibilities assumed on overseas visits.

To ensure a letter of credit is workable, trouble-free and provides the security of payment for which the credit was requested in the first place, it is essential to take simple yet effective precautions at the start. Working through the checkpoints set out in the various sections of the guide will help reduce discrepancies and associated unplanned costs.

Successive surveys by SITPRO and others have shown that well in excess of fifty percent of documents presented by exporters to banks for payment under letters of credit are rejected on first presentation. This can cause expensive delays for both the exporter and the importer and may even result in a lesser payment or no payment at all. A great many of those rejections could be avoided if more care was taken to ensure that the documents called for in the credit are properly completed.

The SITPRO Letters of Credit Checklists and Guides are designed to minimise unnecessary costs and risk when trading on the basis of letters of credit. They are aligned with and based on interpretation of Uniform Customs & Practice for Documentary Credits (UCP), produced by the International Chamber of Commerce (ICC). The current revision, UCP 600, is available from ICC UK (www.iccuk.net).

Payment Options

The exporter should consider whether it is necessary to use a letter of credit or if another method of payment could be acceptable, desirable or more appropriate. You may wish to consider other forms of payment, such as:

Your decision should be based on several factors:

The Negotiating Stage

When dealing with a letter of credit, best practice starts before the credit is received

The terms and conditions of the credit should be agreed at the contract negotiation stage with the importer, considering the following issues:

In order to ensure that all these points are considered the exporter should, where possible, complete the bank application form with their customer. Alternatively, the exporter should provide suggested wording to the importer as early as possible during the sales negotiations. On agreement, it should be built into the sales and purchase contract, reducing the likelihood that goods or payment will be delayed due to problems with the credit.

Note: The L/C should be kept simple and refer to rather than recreate the sales contract. For example, it is preferable to state, “goods provided as per sales contract [number]” rather than reproduce the full goods description.

Essential Checks When the Letter of Credit is Received

Even when these steps are followed, it is essential to review the credit as soon as it is received using the following checklist:

Note: The documents called for should fulfil the requirements stated in the sales contract

Compiling Documents Under a Letter of Credit

Amount payable

Shipment

Individual Documents

Note: Banks will not generally accept liability or responsibility for the consequences arising out of delay, loss in transit or other errors arising in delivery of documents when they are sent in accordance with the credit.

Draft (or Bill of Exchange)

An unconditional order by which the Applicant (the party creating it) orders the Advising bank to pay money to the Beneficiary "at sight" or at a fixed time. It must be drawn in accordance with the terms of the credit, bear the requisite reference number and also comply with the requirements in the Bills of Exchange Act and/or flowing from the rules agreed in the Convention Providing a Uniform Law For Bills of Exchange and Promissory Notes (Geneva Convention, 1930).

You should check that it is:

Transport Documents

There are a number of types of transport document, e.g. sea, air, road, rail, inland waterway, multimodal, courier or postal despatches. The most traditional is the Bill of Lading, which has a threefold purpose: i) formal receipt by the ship owner for goods; ii) evidence of the contract of carriage; and iii) Document of title to goods. In some cases house bills of lading or house air waybills (HAWBs) may also be used against a letter of credit.

Points to check

Insurance documents

Points to check:

Invoice

Points to check:

Certificates of origin

Points to check:

Weight note/list

Points to note:

Courier receipt or Post receipt

Points to check:

What To Do If Documents Are Rejected

A bank has a maximum of 5 banking days after the day of presentation to determine if the presentation is complaint. The bank can refuse to honour or negotiate the credit. If they do so, contact them immediately.

Should the documents be rejected, do not panic, you have the following options:

  1. To correct the documents
  2. To instruct the Advising bank to request the Issuing bank for permission to pay despite the discrepancies
  3. To offer the bank an indemnity if they will pay despite the discrepancies
  4. To send documents to the Issuing bank on a collection basis

Options 1 and 2 are best as they maintain the security of the letter of credit. On Option 3, the exporter may have to repay the money if the importer refuses to pay for discrepant documents. Under Option 4, all security is likely to be lost.

A letter of credit is a quick and secure way of getting paid by your customer provided all the necessary precautions are taken to minimise the risks of discrepancies. It only takes a moment of carelessness to erode the security of using this method of payment and place an exporter in an awkward situation vis-à-vis his customer.

Disclaimer

Whilst every effort is made to ensure that the information given herein is accurate, SITPRO Ltd. accepts no legal responsibility for any views expressed or implied or for any errors, omissions or misleading statements in that information caused by negligence or otherwise.

UCP600 contains the rules for the use of letters of credit. Where there are any inconsistencies with this guide, UCP600 will prevail.

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